Ratings agencies are no substitute for an investor's own due diligence, because their models are fallible and they don't have to suffer the consequences of their mistakes, said CNBS, LLC President/CEO Brian Hague. Furthermore, he said, they are paid by those they rate, and bond issuers can shop around.
So, given that so many formerly AAA-rated investments are now junk, surely the big three-Standards & Poor's, Moody's and Fitch-will reform their business model in response?
Don't count on it, said the Overland Park, Kan. based credit union investment adviser.
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"They could, but I don't think they would do it themselves, nor would the bond issuers force them to," he said. "Neither has any business interest in doing that. I'm not a big fan of legislating everything, but I think a different business model would have to be forced on both ratings agencies and bond issuers."
The increasing complexity of securities "absolutely" contributed to an over-reliance on ratings, Hague said. Egos and job security kept many portfolio managers from admitting they didn't understand what they were buying, but they felt comfortable if the investment was highly rated.
"Very few would admit that, but in a lot of cases, it was the truth," he said.
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