Saturday, February 09, 2008

A Victory for the Credit Rating Market

Just a few days ago I wrote this, and now the WSJ surprises me with this piece (sub req'd). I recalled hearing that Egan-Jones had become a "nationally recognized statistical rating organization" or NR-SRO. This is the pass that Moody's, S&P and Fitch alone had until recently. My understanding is that if you are an NR-SRO designated credit rating firm, you effectively cannot be sued for providing inaccurate ratings because the act of providing your ratings is considered a public service.

This is joyous news! It would be ideal if at least 1 new NR-SRO were chosen. The more competition in the space, the better, as I previously stated. Egan-Jones' business model is much less controversial, since they are retained by their clients to rate credits. They do not get paid by the issuer, as the Big 3 do, so there is no conflict of interest or "ratings shopping" when dealing with them. Also, Egan-Jones just provides their rating - which as Moody's and S&P have stated throughout the subprime debacle, is just an opinion - without having a vested interest in their client's use of that rating. Whether the client is going long or short on the credit that they hire Egan-Jones to rate is unimportant.

So now maybe we'll see some real competition in this market. It won't be easy, but Egan-Jones has been fighting to obtain NR-SRO status for years. Their business model is different and there will be some adjustment required by the market. However, it should be clear that this is a positive development. Look at what happened when the market relied only on ratings from 3 firms, all of whom take payment for their ratings from the issuers of the debt they are rating. While not being the only culprit in this financial calamity, the Big 3 played a central role due to the laziness of investors and the blind faith put into their ratings. Hopefully, now things will start to shift back in the direction of meaningful, trustworthy ratings.

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