Last week, a judge ruled that a lawsuit against the ratings agencies could move forward, and that they don’t enjoy First Amendment protection against fraud claims. On CNBC this morning, McGraw-Hill CEO Terry McGraw tried spinning the ruling favourably, noting that the judge threw 10 out of the 11 complaints out. As for the last claim — the fraud claim — McGraw said there was no fraud. Instead, the company just got it plain wrong.
Like everyone else, McGraw Hill (MHP) didn’t see the epic housing collapse coming, and the effect that would have on various securities they rated. We believe ’em. As we’ve been arguing, this isn’t about incentives or about who pays whom. Lots of folks made error judgments. If you don’t buy Terry McGraw’s argument, explain why you think McGraw Hill should have known all these housing-based securities were rotten, when everyone else in the world was making the same mistake. Even housing “bears”, like Robert Shiller, didn’t see such a big collapse, as Eric Falkenstein points out.
Finally, he addresses the pay-to-play model, and he argues that it’s the only one that makes sense. When issuer-pays, the ratings are freely disseminable to everyone. When a buyer pays, the information stays with the buyer. And what’s more, there’s not much of a business selling this kind of research to each customers. And furthermore, as we’ve noted, it was the demand for AAA securities that created the AAA securitization boom, so the corruption/pay-to-play argument against the ratings agencies holds no water.