Our Townhall colleague Stephen Moore has an interesting analysis of why we should end the credit rating agency racket. While I have some thoughts on a different aspect of this “industry” below, Moore is focused on the role that some of the major entities such as Moody’s and S&P played in the financial collapse of 2007 and 2008. The problem isn’t just the mismanagement of the ratings game and how that led to huge amounts of unsupported credit risk, but the fact that virtually nothing has changed since then and it could all happen again.
[I]t is worrisome that a decade later Washington is engaged in the same derelict behavior that caused the crisis. Government agencies are still issuing taxpayer guarantees on more than 90 percent of mortgages — many with less than 5 percent down payments. Yikes.
Worse, the biggest conspirators in the meltdown, the duopolistic credit rating agencies Moody’s and S&P, which gave sterling AAA grades on these bonds up nearly to the date they collapsed into financial rubble, are still dominating 80 percent of the credit rating market. Why are they even still in business?
Throughout 2007 and 2008, these agencies encouraged investors to snatch up hundreds of billions of dollars of mortgage-backed securities. They told investors these mortgages were “virtually risk-free” and stamped them with AAA ratings. Thanks to this incompetence, millions of Americans lost their life savings, and America suffered one of the greatest financial disasters in our history.
The author has plenty more at the link and it’s worth a read. We are no more protected from such a widescale collapse today than we were ten years ago. But today, I’d like to add on to what Moore is writing about and touch briefly on something that affects most of you on a more personal level.
What about your own personal credit rating? Do you know what it is? And even if you do, can you explain why you have the score that’s attached to your entire fiscal existence? Right off the bat you can consider the fact that the federal government recently concluded that two of the three major consumer credit reporting agencies were blatantly ripping people off and preventing you from seeing the same information that lenders access when evaluating you. Also, they didn’t bother trying to generate a score for most people of more modest means.
None of that is the main issue. Those are just examples of garden-variety greed and corruption. The bigger problem is the way they calculate your score even when the system is supposedly working as intended. Let’s take two hypothetical people here as an example. Mary is a diligent worker and saver who has never been late on the rent, pays all of her utilities on time and promptly meets her other obligations. She has a credit card, but any bills she runs up there are paid promptly at the end of the month. She’s been saving money since graduating college and already has more than 20K in the bank, plus her 401K.
Bob, on the other hand, is living far beyond his means and has been for a couple of years. He’s never been evicted but he has been late on several payments. He has a collection of multiple credit cards. Each one is essentially maxed out or close to it. Each time he reaches a limit, the credit card companies raise his limit a bit more. He makes the payments, but barely, juggling them back and forth. He has no savings.
Who do you think has the better credit rating? Surprise! It’s Bob, and he leads Mary by a mile. That’s because Mary has an established history of covering her obligations, but she hasn’t racked up a lot of debt allowing the credit card company to soak her for fat interest payments every month. Bob, on the other hand, sits on large piles of debt and sends a significant amount of his pay every month to the credit card companies, making the minimum payments.
Mary is clearly the more responsible party, but Bob is the horse those companies like to ride to maximize the amount of money they can get out of him. Thus, Bob has a better credit rating even though he is on the verge of total collapse any day now, just like our economy was in 2007.
Credit ratings are not in place to help you. Nor are they any sort of indicator of your level of fiscal responsibility (unless you’re the sort of person who actually is perpetually broke and misses payments all the time). Those credit rating companies exist to serve themselves and the banking industry. They aren’t looking to give anyone a leg up. They’re looking for suckers they can soak for the most interest possible.