Tuesday, June 24, 2008
Joshua Rosner Strikes Again
Joshua Rosner (JR) has a fine post at http://www.rgemonitor.com/ on 9 June 2008 concerning the Andrew Cuomo's rating agency (RA) "reforms". I agree with all of JR's post except his taking issue with compensating RAs when "the investment bank ultimately selects [another] to rate a RMBS". JR states, "Other than increasing the revenues for these rating agencies, this part of the Cuomo agreement does nothing to address the underlying truth stated by former Moody's Executive Brian Clarkson, 'you start with a rating and build a deal around a rating'." Paying RAs for preliminary work will not increase their total fees as the RAs will charge less to complete a rating. Suppose a RA has a 50% chance of getting an assignment. Each RA's preliminary work might be "worth" say $100,000. The work to complete the rating might be "worth" $500,000, assuming each bills by the hour like CPAs and attorneys. Assuming a RA is rational, how does it quote a fee? It quotes $700,000 to do the work. Why? You have two RA's split the market. Each does $100,000 of preliminary work, one does $500,000 of completion work, total fair value, $700,000. Whether RA A or B gets the $700,000 doesn't make any difference in the long run. I think this proposed reform would cost the investing public nothing and have some "informational content" as revealing a possible "ratings shop" by the investment banker. Good show, JR.