Culprits in housing bubble get to decide U.S. credit rating. Really?

The second act of the theatrical tragic-comedy known as “The Debt-Ceiling Show” is about to begin. In Act II, Scene 1, the credit-rating agencies—[Lower the] Standard & [Make you] Poor‘s, Moody’s and Fitch–pour themselves a brandy, light up a few stogies, put their feet up on the desk, and decide what rating to give the United States.

The whole world is watching. And the characters upon whom the credit rating of the United States depends are none other than those wonderful folks who brought us the housing bubble and crash in 2007 and 2008.

In the absurdist run-up to this momentous day, we watched as politicians, pundits, economists and bureaucrats predicted the dire consequences of not raising America’s debt limit: The all-powerful rating agencies would reduce the U.S.’s credit rating from the top category—AAA—to something less. The results could be economically devastating, they warned.

I’m not an economist, or a banker, or even a person with more than a thimbleful of knowledge about how the rating agencies work. But I do try to keep up with events in the world around me. And it doesn’t take a full-time devotion to economic news to have learned that Standard & Poor’s and Moody’s were among the chief culprits in the housing bubble and its inevitable collapse.

The housing bubble didn’t just happen. It was aided and abetted by the ratings agencies. Basically, they gave undeserved, top ratings to very risky financial schemes, such as collateralized debt obligations [CDOs] and sub-prime, mortgage-backed securities [MBSs]. In subsequent investigations, it has been revealed that the agencies had a variety of conflicts of interest that drove them to endorse financial instruments that they knew to be riskier than the ratings indicated.

Don’t rely on an amateur like me for an explanation. Rent the documentary “Inside Job,” or read what people who actually know what they’re talking about say. For example:

Economist Robert Reich says…

Who is Standard & Poor’s to tell America how much debt it has to shed in order to keep its credit rating? Standard & Poor’s didn’t exactly distinguish itself prior to Wall Street’s financial meltdown in 2007. Until the eve of the collapse it gave triple-A ratings to some of the Street’s riskiest packages of mortgage-backed securities and collateralized debt obligations.

Standard & Poor’s (along with Moody’s and Fitch) bear much of the responsibility for what happened next. Had they done their job and warned investors how much risk Wall Street was taking on, the housing and debt bubbles wouldn’t have become so large – and their bursts wouldn’t have brought down much of the economy.

Economist Joseph Stiglitz agrees…

They were the party that performed the alchemy that converted the securities from F-rated to A-rated. The banks could not have done what they did without the complicity of the rating agencies. “

So, what I want to know is: Who died and left these ratings agencies in charge of judging America’s global financial standing? Buyers of their information, opinions and ratings: beware.