Ratings Agencies: The Monsters Congress Created

It should also be noted that ratings are only important for regulatory reasons. Congress created the game, made these private agencies which are just companies issuing opinions on others, into God-like emperors who pronounce if some debt is worthy of inclusion in a pension fund or not.

Even more important is how AAA securities are treated under Basel and Basel II for capital requirements. AAA securities count 100% towards capital requirements while non-AAA securities start off at 50%. Again, Congress created their own boogeyman through bad regulations. It's important to get regulations right or else very unintended consequences can occur.

People should understand that no large investment or financial management company depends upon ratings to determine risk. Everyone from Fidelity to Paulson with his hedge fund has their own analysts and do their own research. No one except for maybe mom and pop (they probably aren't buying CDOs) use S&P, Moodys, or any agency to determine the risk level of default.

Then why are the agencies important? Because Congress made them so. They're part of the regulatory process thanks solely to Congress. And Congress has frozen out all other competitors, even those who have better track records, only a certain select few ratings agencies can issue ratings that "count" towards regulatory requirements.

Thanks to regulations, it was just too tempting for certain greedy institutions to hold AAA securities that count 100% towards capital requirements and pay a good yield over AAA US Treasuries. The very fact that CDO AAA always yielded more than AAA corporate bonds which in turn always yielded more than AAA US Treasuries shows that the market was aware that not all AAA were created equal. But since regulations treated them equally, we have a little discrepancy that ended up fueling (along with a bunch of other factors) the crisis. Now can people understand why regulations have to be very carefully crafted and the urge to just pass any regulation is probably very stupid?