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February 21, 2013

Break Up the Ratings Oligopoly!

The Justice Department’s landmark lawsuit against Standard & Poor’s has captured headlines and broken the facade of rating-company immunity. But the threat to bludgeon, if not bankrupt, S&P through litigation masks the failure of the Securities and Exchange Commission to reform the raters.

Imposing a settlement of more than $1 billion on S&P may appease the popular cry for the rating companies to pay for their shortcomings in understating financial risks, yet will do nothing to fix the distorted incentives that shape the industry.

Instead, the SEC should take bold steps to use its regulatory authority to transform the industry and break up this entrenched oligopoly in which three firms — S&P, Moody’s Investors Service and Fitch Ratings — provide 96 percent of all ratings and frequently mimic each other’s grades.

The Justice Department’s case against S&P amounts to an indictment of the issuer-pays business model for ratings. S&P, like its leading rivals, is selected and paid by debt issuers. The Justice Department alleges that S&P tilted its ratings to favor the hands that fed its lucrative mortgage-backed securities business, helping to fuel the financial crisis.”

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Read full Bloomberg article here

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