How to Get a Good Service
Moody’s, one of the biggest credit rating agencies in the world, will now pay US$ 864 Million in penalties for misrepresenting the value and risks of the securitized mortgage bonds that collapsed, and were the cause of the great depression of 2008.
There is an ancient assumption that many businessmen are not entirely honest. This also applies to bond and equity shares issuers, promoters and raters. Everyone is anxious to get the “deal” moving, and is loath to throw a wrench into the wheels. Everyone wants to make a quick buck, and walk away. That, is partially the reason why Hammurabi, four thousand years ago in Mesopotamia, issued his famous edicts or laws on trade conduct, and penalties for malpractice and cheating customers.
Moody’s penalty is certainly justified, but whether it is big enough to make any impact to rectify the damage its dishonest ratings caused, is another subject and is open for discussion. But what is most astounding, is how Moody’s reputation remains pure and unscathed, despite its blatant disregard to its declared and promised method of work execution (see our article on the dishonesty of international banks). No wonder the present debate ignores all that, and instead centers around how to avoid such debacles in the future.
One argument presented in a Forbes Magazine article, criticizes the present arrangement where the bond or equity issuer pays the rating agency their valuation fees. Obviously, the rating agency is then beholden to its client, and may bend backwards to please him to retain his present and future business. The alternatives explored were limited to having either the buyers of the bonds or the Government, pay the rating fees. But both alternatives were not deemed to hold water and impractical, thus completing a full circle to conclude, that the existing arrangement, where the issuers pay the rater, is the only viable solution!
We beg to differ. There is one other solution, that would greatly “encourage” the rating agencies to be more prudent and diligent when conducting their tasks. This is to pay them in “kind”. Pay them in the bonds and/or the equity that they have rated, with a caveat prohibiting their resale or disposition in any manner for 5 – 10 years. If the rating agencies do their job well, they would earn more than their mere fees by profiting from any rise in the value of those bonds or shares. But, if they are sloppy or crooked, they get whammed twice, once by ending up with junk paper as fees, and second, lose their reputations and are themselves downgraded.
There is local Arab saying: O’ incompetent baker, eat the bread that you baked!