STOCK MARKET WATCH -- Wednesday, 26 December 2012

[Demeter]

1. Can Open Source Ratings Break the Ratings Agency Oligopoly?

http://www.nakedcapitalism.com/2012/11/can-open-source-ratings-break-the-ratings-agency-oligopoly.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

Yves here. One of the causes of the financial (CRISIS?) that should have been relatively easy to fix was the over-reliance on ratings agencies. They wield considerable power, suffer from poor incentives, in particular, that they can do terrible work yet are at no risk of being fired thanks to their oligopoly position, and are seldom exposed to liability (they have bizarrely been able to argue that their research is journalistic opinion, which gives them a First Amendment exemption). But they are not big enough moneybags to be influential donors, nor are they critical to the financial infrastructure.

Yet they’ve managed to stymie meaningful reforms. Scarecrow and Jane Hamsher detailed how Standard & Poors started threatening to downgrade US debt just as provisions in Dodd Frank that would have made them liable for their opinions, just like other experts, were moving towards a vote. And, mirabile dictu, they managed to get that provision stripped from the bill...Note that the EU is in the process of imposing rules that would make the ratings agencies liable for “mistakes in case of negligence or intent.” This presumably would apply only on ratings of issuers based in the Eurozone; if a European investor relied on ratings to invest in a US security, these rules would not apply. Some commentators are skeptical of other provisions, namely, ones to curb sovereign debt ratings and restrict ownership of ratings agencies.

At the same time, even though ratings of structured products have proven to be sorely wanting, investors still prefer having a bad metric to no metric, particularly since that allows them to shift blame if Something Bad Happens (“everyone else in the industry uses them, we would have lost business if we tried something different”).

One way to remedy this problem would be to reduce the power of the current incumbents by allowing for new entrants. While the SEC initially appeared to be receptive to that approach, people I know with solid backgrounds have found that the SEC is requiring so much capital as to make it unattractive to proceed, thus keeping the current oligopoly intact...Open source ratings is another route for chipping away at the oligopoly. In computers, privately developed operating systems also had a quasi monopoly position, yet open source programs have come to play a more and more important role. And many now forget that in the early days of Linux, most potential users regarded it as simply nuts to consider it. How could you use software where no one was….responsible??? Where there was no business that had an interest in updates and bug fixes? Who do you call if something goes wrong? (That ignores the issue that Microsoft in particular releases buggy software, and that many fine programs nevertheless don’t get updates and upgrades because the developer can’t sell enough copies to make a business out of it). But over time, Linux and other open source software has gone from being bleeding edge to having meaningful market share in certain product areas. So if more independent-minded investors were to find open-source ratings useful (hedge funds, sophisticated individuals and family offices), you could see acceptance there leading it to become a legitimate alternative for institutional investors.