Individual analysts don’t actually have much by way of an immediate incentive to assign aggressive ratings on any individual transaction (note by way that this would involve a group of analysts colluding as all decisions are made by a committee). The incentives come from the broader perspective of senior analysts holding stock in the rating agency and the general culture of ‘getting the deal done’. This is pretty debatable.

The under-resourcing point is as far as I can see not one that anyone is arguing against (i.e. it happens to be true…). As annyoing as it is, the flaws of rating agencies are subtler than the pretty superficial ‘conflict’ argument. One has to establish how the theoretical conflict actually gets converted into a specific rating and what the process is. I have been thinking about it, and this is not obvious at all. Take the consulting/rating point: the reality is the iterative nature of rating agencies’ work in structured finance is not really consulting: since the structures are set up from scratch, the ra’s provide a useful service in providing feedback to the issuers/bankers whether a particular structure would get the targetted rating or not. There is actually a strict prohibition on analysts providign structuring advice to the issuers. So, not so easy to establish this leads to bad ratings.

Have you ever seen bad regulation put in place? Same reason: not enough people, high turnover, lack of time, lack of experiece, pressure/capturing from/by the industry.

The Federal government is sick and may not recover.

Subprime MBS would definitely have gotten a pass, but synthetics might have been slowed down dramatically.

Two, we already have bodies who set tax and accounting rules – you’d have an awful lot of overlap and potentially conflict.

Three, the burden on the regulator would be huge. You’d need an enormous, highly paid staff and sophisticated IT to validate the hundreds or thousands of products proposed every month.

Four, just because a particular product is approved by the regulator, it doesn’t mean that investors will understand it or make wise investment decisions.

Five, on what basis would the regulator approve or disallow products? Simply that the product does what it claims to? Some measure of risk or leverage? I find it hard to believe that such a regulator would not have approved subprime RMBS, say, when it was first introduced.

As I’ve said before, it seems to me the best solution is to regulate the buy side, alongside tough penalties for misselling and fraud.

But wouldn’t a financial products regulator make sense. Every time a bank comes up with a new product they have to submit it to the regulator which will determine legal standards for accounting and tax reporting of the product before approving it. I think this would solve a lot of the gaming of the system that’s been going on. And while I’m sure the “if the regulator wasn’t established in the Constitution, it’s clearly unconstitutional” libertarians will fuss, I don’t how anyone could argue that this would violate common law standards.

The SEC has rules it has to follow and a process that it has to adhere to in order to ensure appropriate transparency and feedback. They can’t just do whatever they want to do and tell people later; I mean, we’re not talking about the Federal Reserve here.

“Let these companies duke it out in full on competition, selling their research to people who are considering buying their rated products.”

That was the gist of my argument, although it wasn’t the focus of my post. I agree with your statement to let the people who want to buy rated products pay for the research. But I don’t need the government telling me which companies do and don’t do a good job.

I presume that failures of the consulting work done on the front end and analytical work done on the back end by the RA’s on all of those structured/securitized financial instruments and entities that received investment grade ratings and then subsequently saw their ratings reduced to junk, were the solely result of an inexperienced and overworked staff and creaking technology? I guess then that none of the folks working at the RA’s were incentivized to bring in additional business and maintain customer relationships.