'Start your own rating agency' Moody's tells governments

In a Telegraph article, Richard Blackden reports how Moody's is challenging governments who complain about the rating agencies to start their own.

Ray McDaniel, the chief executive of Moody's, described the conditions under which such an agency needs to operate

To win the confidence of financial markets, such an agency would have to ensure it was independent of governments and that its opinions were widely available.

The governments should take Mr. McDaniel up and do him one better.

Rather than set up a single rating agency, the governments should adopt ultra transparency across the financial system and create the environment under which many new rating agencies can be formed.

By eliminating the barrier to entry to the rating business, which is access to information and not analytical expertise, the new rating services can use the Internet to globally disseminate their ratings.

Adopting ultra transparency is consistent with the role of governments under the FDR Framework.  Furthermore, under this framework governments are explicitly barred from offering their opinion about an investment.

The reason for this explicit ban is it creates moral hazard.  For example, let's look at what happens when governments announce the result of bank stress tests.  The governments become morally committed to bailing out depositors, bond holders and equity investors should the bank run into solvency problems.

Adopting ultra transparency and expecting new rating agencies to form is also consistent with the FDR Framework.  Remember that under this framework, investors are responsible for all gains and losses.  As a result, they have an incentive to use the data made available through ultra transparency.

Naturally, if they are unable to assess the data themselves, they are likely to use a third party expert... hence, there is a demand for the new rating services.

"Public institutions that have both the expertise and credibility among market participants should provide views on sovereigns," said Ray McDaniel, the chief executive of Moody's. 

To win the confidence of financial markets, such an agency would have to ensure it was independent of governments and that its opinions were widely available, Mr McDaniel wrote in a paper called 'A Solution for the Credit Rating Agency Debate.' 

The suggestion from the head of one of the world's big two agencies is both a rebuke and a challenge to governments who have lambasted the agencies. 

European leaders, led by French President Nicolas Sarkozy, have accused them of deepening Europe's debt crisis by downgrading the ratings of key countries in the euro. 

"Rather than stifle those opinions, policy makers should neutralise private-sector rating opinions by introducing a public-sector voice to contribute competing views," according to Mr McDaniel.... 

Some European critics have argued that the agencies should be banned from making public their opinions on the creditworthiness of governments, but Mr McDaniel argued that will not stop investors from speculating and making their own judgements. 

In the paper, Mr McDaniel suggested that establishing a public credit rating agency was down to the strength of political will there is to do it. 

The agencies have faced a wave of criticism from European governments over the last 12 months, and this week the European Union's top markets regulator delivered its own warning. 

The European Securities and Markets Authority said that the companies must improve their internal processes or face possible action from the regulator. Moody's said that it was committed to "continuing to enhance its rating process."