I suppose a diary shouldn't just ask a question, but I can't get this out of my head, I'm too old to know any college kids to ask, and too shy to ask Paul Krugman.
I don't understand why anyone needs these slimy rating companies any more.
One of the protections that's supposed to be in our financial system is that investments get rated (like AA) and then funds use ratings to control the risk in their portfolios. As a rapidly aging hippie, I want my IRA in pretty low-risk stuff now. I was shocked (well, maybe just chagrined) to learn that the rating agencies get paid for their rating by the people issuing the instrument getting rated. Is that a sweet deal or what? I'd like to get into that business, but I think they've set up some barriers to entry. Whatever..
But then I've learned in the last 2 years about this thing called "Credit Default Swaps", in which one institution happily guarantees the integrity of an investment to another one, for a wee fee. The owner of the security is protected against default that way. It's insurance. Better insurance than that perky Progessive lady sells because Timmy G stands behind it.
Now in the real world, insurance rates are set according to risk. Certainly, I would expect the cost of a CDS to be a direct measure of how the market, in its wisdom, evaluates the risk of a security.
So if we have an institution willing to guarantee a security at a price, why isn't that the perfect way to evaluate the risk of the security? What the hell do we need Moodys for if AIG is willing to set a price on a guarantee? AIG's price for a CDS should tell us exactly how risky the security is. And if it goes belly up, AIG pays.
I say CDS's for everyone and do away with the raters!