Here’s a great piece in WaPo by Steven Pearlstein that outlines the trouble with rating agencies.

>One thing you learn from booms and busts is the importance of gatekeepers — those professionals who are supposed to safeguard the system and keep markets honest. When gatekeepers are compromised or fall down on the job, confidence evaporates and markets collapse.

And its been wrong for a while…

>starting in the mid-1970s, following a number of high-profile bankruptcies, people decided it was important to make credit ratings publicly available to all investors. Companies that issued bonds began paying for the ratings themselves, and it didn’t take long before agencies figured out that it was better for business if their ratings were a bit higher and their analysts were a bit slower to issue downgrades

Finally, after more than a year

>the SEC rolled out a bunch of new rules and proposals meant to purge conflict of interest and ineptitude from the credit-ratings agencies—that group of companies whose greatest hits include considering Enron investment-grade until four days before it went bankrupt and, most recently, the “AAA-rated” CDO.

In 2005, I had lunch with a bunch of investment bankers and they spent most of the meal ripping the incompetence of the rating agencies – how they couldn’t keep up with the new financial products and the disrespect for their “hand in the cookie jar” arrangement.

As it stands now, you can’t really build investor confidence in the secondary mortgage market until you (substantially) remove self-dealing. Rating agencies were paid by the banks whose paper they rated. Crazy.

>The Commission approved a series of proposals designed to strengthen its oversight of credit ratings agencies, enhance disclosure and improve the quality of credit ratings. The proposals would improve the quality of ratings by requiring greater disclosure, fostering competition, helping to address conflicts of interest, shedding light on rating shopping, and promoting accountability.

And thats not all – California is going after the agencies themselves.

>The three top agencies — McGraw-Hill’s (MHP, Fortune 500) Standard & Poor’s, Moody’s (MCO) Investors Service and the Fitch unit of France’s Fimalac — raked in huge fees in exchange for assigning high ratings to “complicated financial instruments, including securities backed by subprime mortgages, making them appear as safe as government-issued Treasury bonds,” Brown’s office said in a statement Thursday morning.