This Week’s Sign the Lunatics Are Running the Asylum

Among the most-needed changes currently under debate in the pending financial reform bill in Congress is an overhaul of the ratings agencies. These agencies get paid by the firms whose products they rate – a rather obvious conflict of interest that has nonetheless received indirect government support for many years. The high quality ratings bestowed upon the piles of financial garbage that eventually blew up and led to the recent credit crisis came from the Big Three rating agencies – Moody’s, S&P and Fitch – a cartel, if you will.

If you have any doubt about the need for reforming the credit rating agencies, and The Great Recession wasn’t evidence enough, I’d highly recommend Michael Lewis’ The Big Short
for some perspective. And after all we just went through, it’s hard to imagine anyone in charge of managing others’ wealth expressing any kind of support for perpetuating the current system.

But then there are the mutual funds. From an article in today’s WSJ (emphasis mine):

Making this tale even stranger than fiction, S&P has said it is ready to give up its special status. The political problem now is that the mutual fund industry is lobbying to maintain the cartel. Both regulators and fund managers have figured out that doing their own analysis to decide what constitutes an “investment-grade” bond is hard work. But if some third party (such as Moody’s) has deemed a bond safe, no one can second-guess the mutual fund for owning it.

To put a finer point on it, the raters give mutual funds a shield from lawsuits if their investments go sour. All the more so because the Senate and House reform bills contain provisions that will make it much easier for plaintiffs attorneys to sue the credit raters. As long as the cartel remains, everyone is covered—except the individual investor, who loses money when the cartel members rate the next Enron as highly as they rated the last one.

The irony is that it’s the individual investors in those funds who are helping to pay for the same lobbying efforts that end up screwing them over.

Sigh. Long live Spoke Funds®.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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