In a 10-minute presentation, Toby Segaran and Jesper Anderson talked about their new company Freerisk. It's an interesting concept. The idea is to make rating agencies obsolete.


I heard an explanation of the financial meltdown by a former Bush economist last week who placed most of the blame on the rating agencies. Although I would argue an equal blame should be placed on investors blindly trusting the rating agencies without performing any due diligence of their own, the rating agencies clearly dropped the ball.

Like so many others, Segaran and Anderson also dislike the current rating agency structure. They began by explaining how the current structure of rating agencies is problematic. The rating agencies have an incentive to be liberal with their ratings so that issuers use them as they fight for a larger share of the ratings market. After all, issuers pay the bill. If an issuer does not like the rating agency, then they can cherry pick and go to one of their competitors who might provide a more favorable rating. (Though, in my experience as an investment banker, investors usually see through cherry picking and issuers consequently avoid the practice.)

They also lamented the fact that we have an oligopoly of rating agencies in Moody's, S&P and Fitch. This stunts innovation, as they don't need to work hard to create better models, since there is not much competition.

Their answer is Freerisk. Although it does not appear to be up and running yet, the idea is to aggregate financial data and to provide tools to perform the analysis. It seems like a nice idea, I'm just not sure it will work.

Their contention must be that investors did not do their own due diligence, and their site would make that process easier. Maybe. But the investors who bought the securities that went bad -- particularly stuff like Mortgage-Backed Securities -- are large institutional investors. This isn't your friend Joe who trades stocks in his spare time. They almost certainly already subscribe to sources like Bloomberg or Reuters who aggregate all of that data. They also should have people with the minds and excel skills to create the models necessary to perform legitimate evaluations. If not, they will in the future.

Maybe I misunderstand the concept for the website, but the only other potential use of the site I can imagine would be to serve as a kind of forum for what investors have independently concluded about various securities. This, however, seems like it would kind of have the wikipedia problem. Would you really trust a bunch of faceless parties to derive an investment conclusion? I don't know about you, but I would prefer an imperfect rating agency. At least then there's someone to blame when it all goes bad.

Instead, I think there are other more fundamental ways to address the rating agency problem, such as investors paying for the ratings instead of issuers or lifting rating agency regulation so to remove barriers to entry and enhance competition in the ratings marketplace.

Still, their concept is interesting. I'm just unconvinced investors have the motivation to do the leg work themselves. If they did, then they probably would never have relied so heavily on the rating agencies in the first place. Freerisk might cater to their laziness, but there's still some heavy lifting that will have to occur by the investors one way or another.

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