Credit Rating Agencies "Look Like Idiots"

The Financial Times published "Emails Detail Role of Ratings Firms in Crisis" today.  It appears that employees of the two big credit rating agencies (Standard & Poor's and Moody's) thought that their firms' own ratings of some mortgage backed securities were faulty.

A big problem in the way the ratings market does its job is who pays for the work.  When S&P or Moody's are hired to rate a fixed income security about to go to market, they are paid by the people trying to sell the security.  This incentivizes the rating agency to rate in favor of the security seller, to encourage future business.

This is akin to you trusting a used car dealer's mechanic regarding the quality of a car you are considering to buy.  A savvy used car buyer has the car checked out by their own mechanic before buying.  Of course, this means you likely pay your mechanic for their trouble, but that fee is worth the information you gain before making the commitment to buy the car.

Investors should be doing the same thing with their fixed income securities.  Go hire your own credit rating agency.