If Ratings Agencies Disappeared

Would Wikipedia or Google do a better job? Moody’s chief economist Mark Zandi weighs in.
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Question: Do you believe that bonds could one day be like stocks where analysts present their opinions rather than the market relying on the ratings of few agencies? (Dan Indiviglio, The Atlantic Business Channel)

Mark Zandi: Well, I think to some degree that happens now.  I mean, all the folks that work at various investment houses, buy side analysts, do spend a lot of time and energy trying to understand the risk characteristics of bonds and determining whether they are good investments or not.  So, that happens already.  They take the ratings as one other opinion in their decision-making process, whether to make an investment. 

I think, going back to securitization-- that was complex.  That was more difficult for analysts at these investment houses to evaluate in part because they didn't have all the information and data and in part because the securities were really very difficult to understand and so they didn't have the same level of understanding and they didn't do the same kind of due diligence as they did for say, a municipal bond or for a corporate bond, or a sovereign bond.  But I think that's going to change going forward if there ever is another structured finance deal that's done, you'll see a lot more analysis put into it. 

Question: What if ratings agencies disappeared? Would Wikipedia or Google do a worse job? (Tyler Cowen, Marginal Revolution)

Mark Zandi: I think there's a function for rating agencies because in a sense, there is a lot of despaired information and bringing it altogether is very costly and doing good analysis is difficult and you need scale to do it.  Some bond houses are gaining that scale and doing that on their own.  There's the PIMCO's of the world and other big bond houses that have the skill necessary to put together the staff to do the kind of analysis that needs to get done.  But many other investors don't have that scale and the rating agencies, in a sense, provide that for them.  And so, there are scale economies in that kind of analysis and in a sense the rating agencies provide that.

Also, there's a lot more esoteric kinds of bonds and securities that are issued and it always will makes sense to have, I think, something like a rating agency providing an opinion as to the quality of that particular bond or that security.  So, I think there's an economic reason for rating agencies, so I think they will always be around, obviously the role is going to change as a result of events, but I think there will always be a role for them.

Recorded on November 10, 2009