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Independent Bond-Rating Agency Barred from Rating US Debt Obligations

Posted: January 24, 2013 at 4:00 am   /   by

Everyone has heard of S&P, Moody’s, and Fitch.  These are three of nine agencies authorized to rate US Treasury bonds for their credit worthiness. Investors worldwide count on these agencies to do the painstaking due diligence on those bonds to help them judge whether to buy a bond (or not) and how much to bid for it.

All the agencies except one are paid by the bond issuers, creating an implicit conflict of interest.  The one exception is Egan-Jones, a small credit-rating firm that is paid by bond buyers rather than bond issuers. Consequently, their ratings have higher implicit credibility, although it seems most polite folks don’t like to talk about that.

With our US Treasury piling on debt at a record-breaking pace, US securities face the risk of more ratings downgrades, and everyone knows it.  The result could be lower bids and (consequently) higher interest rates demanded by creditors. At some point there could even be (heaven forbid) a failed treasury auction — no buyers — not even the Federal Reserve. That could cause the entire US financial system to seize up like an engine throwing a rod.

Egan-Jones has already downgraded US debt not once but twice.  A third time could presage disaster for the Treasury Dept.  So what’s our poor Treasury Secretary, Timmy Geithner, to do?  Well, we have no way of knowing what goes on behind the scenes, but on January 22, the SEC barred Egan-Jones from rating certain US Treasuries for the next 18 months. 

Phew!  That was a relief, eh, Timmy?

Egan-Jones agreed to the suspension as part of a settlement on charges, filed in April, 2012, that there were some technical errors in documents they filed way back in 2008.  How convenient!  The swift, certain, SEC sword of justice arrived just in time to avoid (or at least delay) another possible downgrade of US debt.

The original investigation into Egan-Jones began just after their first downgrade of US debt.  Coincidence?  Who knows?  But the only rating agency beholden mainly to bond buyers has just been knocked out of the loop. So caveat emptor, buyers beware!

And as for all you other rating agencies, take note. If you issue a downgrade, deserved or not, you too might suffer the consequences of a coincidental SEC finding. You have so many wonderful employees, too. It would be a shame to have to lay them off, no?

Score another one for what Barack Obama told us is “the most open and ethical administration in history!”