Financial Reform Killing Off Bonds By Both Requiring Ratings & Making It Impossible To Rate Bonds
24th July 2010
Ah, the unintended consequences of bad legislation. It’s no surprise that many people have pinned a lot of the blame on the financial crisis on the ratings agencies (mainly Moody’s and S&P). After all, they were the ones who went out there and said that collections of slices of dices of the worst mortgages around should be rated as top notch, sure-fire, investments. And there were clear conflicts of interest in how the ratings agencies did their ratings. But, in the end, the ratings agencies were really just giving an opinion — and opinions are (last we checked) supposed to be protected by the First Amendment.
The real problem came from the government writing those agencies’ ratings into the law. Basically, the government, in a really short-sighted attempt to avoid financial problems, required certain institutions had to maintain a percentage of “highly rated” or “investment quality” bonds, in order to engage in certain activities. Suddenly, these “opinions” weren’t just opinions, but had important legal consequences. If a ratings agency downgraded an investment, it could legally force some holders of those bonds to have to sell them to maintain its investment ratios. With that, those ratings also took on the sheen of something objective and factual, rather than a random opinion put forth by a bunch of guys (mostly guys) who might not know what’s really going on, and who have some serious conflicts of interest.