Incompetent S&P’s Day of Reckoning?

Felix Salmon has an excellent piece on how S&P royally effed over some municipalities in Australia and now might actually have to pay for its incompetence.

Put it all together, and you get a very shocking view of S&P. Here’s the list:

  • S&P used the wrong model input for starting spread.
  • S&P used the wrong model input for volatilty.
  • S&P used the wrong model input for average spread.
  • S&P completely ignored ratings migration.

If S&P had just got any one of these things right, the CPDO would never have gotten that triple-A rating. If it had got them all right, the CPDO would almost certainly not even have been investment grade, let alone triple-A.
S&P was not doing its job, and as a result a bunch of Australian municipalities lost a great deal of money. Jagot has found S&P liable, as she should. Good for her.

I’ve written about rating agencies before: they run a government-granted oligopoly grading financial instruments.

The big news here is that the disclaimer that rating agencies use, “don’t blame us if it goes wrong!” has actually been thrown out.  Is this the beginning of the end?

The thicket of industry regulations (and practices) that depend on these ratings is deep. If change is to happen, it would start in some jurisdiction that’s willing to roll the dice. Australia’s regulator, APRA, is a fairly progressive institution so perhaps we’ll see a competing model emerge.

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