Thursday, October 23, 2008

Corporate credit-rating agencies seen as having inherent conflict of interest in their business models

Media reports are now questioning the way corporate credit-rating companies are managed. Standard & Poor’s, Moody’s, and Fitch all underestimated the risks of the derivates and various other securities held by firms that they rated. The problem with their business model is that they are funded by the issuers of the securities that they regulate, and this is an inherent conflict of interest.

That would be comparable to a credit reporting company on individual consumers being paid by consumers (although applicants for mortgages do often have to pay for their own credit checks, as do applicants for apartments).

The Washington Post story is by Amit R. Paley and is titled “Credit-Rating Firms Grilled Over Conflicts; Risks Were Known, Documents Show,” on p A1 of the Oct. 23 Washington Post, link here.

Executives from the rating companies testified before Congress this week.

The threatened downgrade of AIG in mid-September after Lehman Brothers collapsed was a major pinwheel in the unfolding of the urgent financial crisis.

I’ve written a lot about “personal” conflict of interest, such as working for a company in such a way that you make underwriting decisions about clients against whom you publicly express a personal political bias.

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