How many times have you heard statements to the effect that bond credit ratings must be biased since institutions that issue bonds pay for these ratings? A lot, probably. These statements are shallow, and wrong. The fact that someone pays to be evaluated does not mean that the evaluation must be biased. If you decide to go to grad school, you'll probably have to take the GRE or some other standardized test. For that test, you'll have to pay the testing company. Does this mean your score will be biased in your favor? Definitely not. Why not? Because test scores, as long as they're not biased, provide schools with valuable information about prospective students, so they want those prospective students to be screened that way. If test scores were biased, schools would no longer require them, which means prospective students would not be willing to pay for them anymore. Even though test-takers pay to be tested, testing companies have strong financial incentives to keep test scores as honest as possible.
Test-taking companies stay in business because schools utilize their test scores as representative and honest. Fine. There's a third party. If a business pays to be evaluated by an "Evaluation Company" then who is the third party who keeps Eval Company straight and narrow?
ReplyDeleteAs a bond buyer, wouldn't you want to be reasonably certain that an AAA bond is safer than an AA+ one? And if the ratings don't provide you with that information, wouldn't bond-issuers stop paying rating companies?
ReplyDeleteSounds fine in the aggregate, but I'm guessing that there can be under-the-radar fraud that makes the system fairly corrupt. I don't know enough about it to say any more, though.
ReplyDeleteMaybe so, maybe not: it's beside the point. The post isn't about whether the ratings system is or is not corrupt. What I am saying is that the statement "The ratings system must be corrupt because bond issuers pay for their ratings" is demonstrably false.
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