Earlier, Megan posted a section from a suggestion from Joe Wiesenthal at Clusterstock on how to fix the rating agencies. He suggests a group of 10 agencies, arbitrarily chosen to rate deals. Since I have some pretty strong opinions about the rating agencies, I thought I might give this proposal some thought.
Here's Wiesenthal's solution to the rating agency problem:
You create a pool of 10 companies licensed to rate debt. When an issuer wants to bring a security of some sort to market, they tell some central body, and a rater is selected at random from the 10. There's no changing it once a name is selected. Thus the debt issuer can't go ratings-agency shopping if they're worried about what kind of ratings they can get.
If a debt issuer isn't happy with who they got, then, well, too bad. Over time, you'd give companies that showed a good track record a heavier weight in the pool, so that they're selected more often. Their only goal would be to increase market share by being accurate. Pandering to either buyers or sellers would be 100% impossible.
Now granted, it wouldn't be perfect. Performance measures would be backwards looking, and you'd probably end up with companies that had gotten lazy, and stuck to old ideas about how to rate debt, but that's just life. They'd lose their weighting in the pool, and eventually you could even put companies on probation if they got bad enough.
Nothing's going to change the fact that incumbents grow dumb and slow -- but at least they'd have an incentive to avoid that, whereas currently they don't (have the top raters lost any market share? No.)
I think to evaluate this solution we should consider whether it would have solved the problem that we ran into the past few years. I don't believe it would have.
As Wiesenthal admits, the performance measures would be backwards looking. Prior to 2007, the three rating agencies actually had a very good track record. There was no reason to believe that their ratings would suddenly collapse. So how can we have any certainty that those agencies with the highest market share out of the chosen 10 would have done any better than Moodys, S&P and Fitch?