Ratings agency model is broken

My father was a panel beater. He ran what the Americans would call a body shop. In the days before insurance companies got smart and  started issuing their assessors with standard schedules for various types of collision damage, my father made a very good living by manipulating the prices of parts, labour and so on. He occasionally substituted second hand parts for new parts and so on, which wasn't strictly legal -- but it was highly profitable. Above his shop he had a battered sign which said "All care but no responsibility taken."  According to my legal friends, that declaration has no legal status, which he found out to his cost several times.

The ratings agencies have always operated on the same principle. Their business model has always struck me as being very peculiar. And now an Australian judge has ruled that the "All care but no responsibility" model is worth about as much as the sign above my father's shop when it comes to offering them protection from legal remedies.

For those of you who don't know how their model works, the ratings agency will rate a product, and be paid by the firm issuing the product. Is it any wonder then that the ratings agencies rated CDOs (colatoralised debt obligations) AAA when they should  have rated them c.r.a.p.? Of course, then no one would have invested in them, especially as some bodies have a statutory obligation to invest only in financial instruments with a certain rating.

The Federal Court of Australia ruled on November 5 that Standard & Poors was jointly liable with ABN AMRO for the losses suffered by local government bodies in Australia when they bought the product promoted by the bank. The ABN AMRO product, called a "constant proportion debt obligation" (CPDO), was a wonder of financial engineering best described in layman's terms as "double up or quit" when the market went down. S&P denied its ratings were inappropriate and aims to appeal the ruling. The AAA rating S&P gave the CPDLOs meant that the ABN AMRO product has as much chance of going bust as the US Treasury. A sadly inaccurate expectation .

Now the ratings Three Stooges -- S&P, Moody's and Fitch -- are defending some 40 similar cases around the world. The standard defence is that ratings are only "opinions"  and no one should rely on them. If they are only opinions, why have them? And why is there a statutory requirement for many investors -- including government bodies -- to only invest in financial instruments with a certain rating?

Some say Moody's, commonly held to be the best of the bunch, must be good because Warren Buffet, the Sage of Omaha', is a major invest. Sorry, much as his acumen and integrity draw near universal acclaim, he is a businessman, not the Good Housekeeping Seal of Approval.

Instead, what about asking investors, who are using the service, to pay for it? Cash flow might suffer, but it would seem to be a better method of promoting accuracy. "The Big Short: Inside the Doomsday Machine" Michael Lewis's excellent account of the collapse in the  CDO bubble, demonstrates what can happen when the ratings agencies go haywire. In the meantime, who are the ratings agencies kidding? Are they seriously saying they are producing a product on which investors can't rely? If so, why bother?