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March 23, 2009

Credit rating agencies are broken

I have spoken many times about the credit rating agencies. Their model is broken.
- Pennsylvania Railroad went into receivership in 1970 – rated triple A.
- Venezuela defaulted in 1982 – rated triple A.
Over the past several years lots of structured products were rated triple A only to go to triple C in the blink of an eye.
Rating agencies are paid by the issuer. Why would a buyer of securities rely on a rating provided by the seller.
Companies rate shop. They visit all the rating agencies and give the business to the agency which accords them the highest rating.
Mary Schapiro, the incoming Chair of the SEC, testified earlier this month, “until we deal with the compensation model, we’re not going to deal with a conflict of interest and people are not going to have confidence that the ratings are worth relying on, worth the paper they are printed on”.
In my opinion, rating agencies are dangerous because they provide investors with a false sense of security.
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