Thursday, August 2, 2007

We need to eliminate the financial fortune-telling franchise.

I have nothing against the credit rating agencies, in fact I would like to have hundreds of them instead of the current only three. What I do not like though is when investors are forced to act in accordance with what they opine since when someone is told that someone else does the thinking for them, they lose the motivation to think for themselves and they have been empowered with the perfect excuse to hide their own shortcomings.

When you tell a pension fund it is not allowed to invest in anything below a specified level of ratings you are sending two messages. The first, that pension funds should only invest in safe ventures sounds about right but goes against current financial theories that say that a perfect blend of uncorrelated potions could just as well be the safest bet in town. The second message, the truly dangerous one, is that you are implying that there are objectively safe investments in the world and that the credit rating agencies have the tools to spot them.

We have already gone much too far down the road to a systemic risk explosion and we can already smell the subprime gases that have been accumulated. Anyone who lives in an earthquake prone region knows to be grateful for the small tremors that release the build-up of tensions and keeps the big one away. In these days we pray that the current financial uncertainties are only a minor tremor but if we really want to avoid building up the tensions that will lead to a true catastrophe, one of the first things we must do is to dismantle the fortune-telling franchise awarded by regulators to the credit rating agencies.