How Failure Leads To Profit

Sometimes no matter how badlyou screw up, good things just seem to keep coming your way. The exhibit for today is the credit rating agencies.

The WSJ reports that despite their abject failure to properly assess the risk of securitized loans Moodys, S&P and Fitch are in line for a big payday thanks to TALF.

Under the so-called Term Asset-Backed Securities Loan Facility, or TALF, the Federal Reserve will lend money to investors who buy securities backed by such things as auto, student, small-business and credit-card loans. But the government, hoping to protect itself from losses, will allow its money only to be used to buy securities rated triple-A by the ratings services.

Rating services typically charge $40,000 to $120,000 for every $100 million in so-called structured-finance securities they rate. For the initial $200 billion portion of TALF, that translates to $80 million to $240 million. If the program is extended to $1 trillion as the government plans, those fees could skyrocket to anywhere between $400 million and $1.2 billion.

Critics say Moody’s, S&P, a unit of McGraw-Hill Cos., and FimalacSA’s Fitch have made few fundamental changes to the way they assess debt. Officials at all three firms say they have taken steps to avoid a repeat of past mistakes in assigning ratings.

They are still paid for their ratings by the companies whose bonds they rate, a potential conflict of interest. And much-anticipated competition for the three companies has failed to materialize so far.

You may recall all of the talk a few months ago about how we had to wean ourselves from this sort of reliance on third party opinions of credit worthiness. That lenders and investors had to assume more responsibility for credit analysis and that the ratings from the agencies were worth little more than an analysts opinion on a stock. Did we decide that was the wrong approach and that the third party route was really the best way?

I guess so since I haven’t read anything to the contrary. Someone must have decided that it made sense to go back to these guys and this time it would all work out fine.

Truly, I don’t know what the proper course might be. I do know that the urge to have a third party to blame if things don’t work out is a powerful driver. Under no circumstances does the Fed or the Treasury want to go before Congress and say the deal didn’t work because our analysis was incorrect. Far better to say that we relied on someone else who should have known better so what else could we have done.

Amazing how quickly we get back to business as usual, isn’t it. How does it make you feel about the prospects for real reform, though?

Update 3/23/2008 – I received an email from S&P advising me that the WSJ had erred in their article. S&P’s fees from rating the TALF securities are not of the magnitude as portrayed by the WSJ article and have caps as well. Here is a link to a S&P site that clarifies their fees and states their position on their performance.

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