Tuesday, April 8, 2008

Quality Is as Quality Does: Ratings Agencies' Failures in Mortgage Crisis Put Question Mark over Content Value

I've done quite a bit of research through the years for people in the securities ratings industry, a very interesting arena in which financial experts from major ratings agencies are paid by institution to rate the financial quality of their debt and stocks issued and traded in the securities marketplace. In turn these ratings agencies sell their ratings research to financial content vendors and directly to financial institutions. The content side of the business is nowhere near as lucrative as the ratings side, especially in the arena of stock research, where ratings agencies must now compete with independent research mandated by reform-oriented regulations. But in the arena of structured finance, in which bonds, mortgages and other types of potentially risky investments are repackaged into portfolios that offer more understandable and acceptable risk, ratings research has been in theory a useful tool to help people understand these complex investments and to provide market liquidity that might not otherwise exist.

That is, until the current mortgage crisis erupted. In many instances major ratings agencies were assigning very rosy ratings to the structured finance packages developed to package highly risky mortgage debt into more palatable forms. Yet these complex packages went south very quickly in the markets once many of the underlying borrowers failed to be able to adjust to the draconian interest rates that were triggered by their home loans' contractual terms over time. In short much of the market for these mortgage-backed structured investments, supposedly built on the highest quality research and analysis into investment quality by major ratings agencies, was built upon sand that crumbled away at the first real signs of financial trouble.

It would be unfair to assign blame to ratings agencies entirely for this whole mess, but from the perspective of the content industry the role of ratings agencies in this now-global financial disaster calls into question just what it is that people are paying for when they purchase financial research from ratings agencies and other suppliers of premium business information. The main problem that I perceive is that there has been an erosion of the power of editorial checkpoints within the ratings agencies that were supposed to act as a strong counterbalance to the all-too-natural tendency to put the lucrative process of getting paid by an institution to offer an opinion about their securites ahead of the objectivity of the research produced by that process. For debt markets rating the risk of securities is one of the oldest "cash cow" businesses in financial information, a tight setup in which just a few government-recognized agencies in the U.S. get rate bonds and structured finance debt packages with no real competition. It's no surprise, then, that pricey ratings contracts from debt issuers lured ratings agencies into editorial complacency.

The securities industry, of course, is not the only instance of such cozy setups. For example, we all know that there is an inherently incestuous relationship between major I.T research firms and vendors eager to have their products appear in their widely distributed research papers focused on specific types of technology solutions. B2B and consumer magazines reliant on income from major advertisers feel the pull of major accounts who are eager to have their products treated fairly by their editorial staffs in their articles and product comparisons - especially in niche market publications where there are a relative handful of major advertisers available. Bias is always a temptation when the bottom line beckons.

But in the instance of financial securities the stakes can be much higher, as seen in the trillion-plus U.S. Dollar estimate for settling out the bad debt in the marketplace. The moral of the story should be clear to all content providers: the cost of compromising editorial quality can be far greater than your own bottom line in the short run, and can level the value of your brand as a source of editorial quality in the long run.
Post a Comment