Public agency should rate securities

In the rarefied world of Goldman Sachs, money talks, but apparently it doesn’t listen very well. The investment firm’s announcement that it is on track to pay huge, pre-economic-meltdown- level bonuses to its executives and traders means it is utterly deaf to the simmering resentments of everyday Americans whose desiccated pockets bailed out Wall Street’s bulging ones.

Goldman Sachs made big earnings in its second quarter by taking financial risks that other banks are shying away from. The firm thinks it has emerged from the economic crisis – during which it was lent (and has since repaid) $10 billion by U.S. taxpayers – with its old game plan intact. “Eat what you kill” remains the compensation model, with high-stakes risk-taking richly rewarded.

Pitchforks, anyone?

It is clear that investment firms are not going to voluntarily change, but there is a way to keep their greed-fueled party from crashing the economy again: Reform the credit rating agencies.

I am still flabbergasted that Standard and Poor’s, Moody’s and Fitch, the top three credit rating agencies, remain in business when their risk assessments turned out to be such self-serving junk. They were so busy giving top AAA ratings to securities backed by questionable subprime mortgages in exchange for lucrative fees that they just about sank Wall Street.

A lawsuit just filed by Calpers, California’s public pension fund, illustrates how craven these firms are. It wasn’t enough that their wanton bestowing of top credit ratings made them a fortune from the packagers of mortgage-backed securities. The suit says that the rating agencies themselves dabbled in the creation and operation of structured financial products – making even more money in the process. Then they rated their own work.

When their AAA-rated “structured investment vehicles” subsequently tanked, investors lost their shirts, including Calpers, which alleges it is out upward of $1 billion.

Securities and Exchange Commission Chairwoman Mary Schapiro told Congress last week that she wants to decouple the financial sector from its reliance on the rating agencies. Good idea, but Wall Street strongly opposes it, so we’ll see if it has any legs.

But I like even better a suggestion for a public credit rating agency. A group of economists wrote in The Economists’ Voice that as long as the rating agencies are paid by the issuers of securities, there will always be a strong bias for a favorable rating. They suggest that a government agency provide a risk assessment for every financial instrument in the same way that the Food and Drug Administration evaluates new drugs for health risks.

If the agency were kept free from political influences, it could work.

The big payday planned for Goldman Sachs executives indicates that Wall Street is still loopy with champagne wishes and caviar dreams. Taming such greed through government regulation is not enough. The banks will find a way around it. But giving investors a true picture of the riskiness of what Goldman Sachs and the like are selling would slow the gravy train and bring new stability to the entire financial system. The big credit rating agencies can no longer be trusted with this job. A new public agency is just the ticket.