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"Sticking out like a sore thumb": Alan Blinder wants to reform the ratings agencies

Aaron Task
Daily Ticker

Nearly six years after the financial crisis sent the global economy reeling and nearly four years after Dodd-Frank legislation passed Congress, not much has happened to address one of the key causes of the 2008 meltdown: The Rating Agencies.

"It is scandalous and barely believable...that credit rating agencies are still being hired and paid exactly as they were in the bad old days," Princeton professor and former Fed vice chair Alan Blinder writes in his latest WSJ op-ed.

In the accompanying video, Blinder discusses three proposals to address the "issuer-pays" model of compensation:  

Increase agencies' legal liabilities: "As things stand now, it is nearly impossible to sue a rating agency successfully...because ratings are deemed to be 'opinions' protected by free speech," Blinder writes.

Pay rating agencies via a third party: "The nub of the problem is the people getting these ratings are paying for them," Blinder says. If rating agencies were paid by "something other than the companies issuing the securities" -- like an exchange or a regulatory agency -- the rating agencies' natural tendency to please their customers would no longer lead to "inflated ratings."

Random ratings: To minimize 'ratings shopping' by issuer, Blinder says agencies could be assigned to issue ratings, not unlike how judges are randomly assigned to handle various cases. "You don't get to pick your judge, you certainly don't get to pay your judge," he quips. Choice would be random. "You don't have an issuer deciding 'I'll go to A vs. B because they have a softer touch.'"

Blinder admits there's little or no momentum today to address the rating agencies, which he says is precisely why he wrote the piece.

"A lot of people have forgotten that one - not the only - but one of the major factors leading into the crisis was the mountain of undeserved AAA ratings the rating agencies hanged out in 2006 and 2007 of securities that never should have gotten AAA," he says. "It's standing out there like a sore thumb of a problem that was fully realized -- everybody knows the rating agencies fell down on the job -- but literally nothing has been done."

Aaron Task is the host of The Daily Ticker and Editor-in-Chief of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com.

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