Rating agencies receive a 'D'

The US Securities and Exchange Commission (SEC) is expected to issue proposals for restructuring the credit ratings process on Wednesday. The problems are both human and technical: the credit ratings process has recently been hit by allegations over defective computer models, failure to correct known errors, and inappropriate responses to pressure by debt issuers.

Moody's Investors Services, the largest of the three dominant credit ratings agencies, announced in May that an internal computer model error had led them to report AAA ratings for certain credit derivatives -- up to four notches higher than warranted. Disclosure of the problems led to a significant decline in the company's share price, and the placement of the company's own commercial paper rating on 'credit watch' by its competitor, Standard & Poor's (S&P).

Moody's undoubtedly will be targeted at several legal levels, both public and private, as a result of these disclosures. The SEC has initiated probes that at minimum could result in civil lawsuits against Moody's and other agencies. The most significant change expected will be to require risk ranking for structured products, thus separating these currently same-rated products from corporate and municipal bond ratings.

Yet the SEC may emerge from the debacle with the least credibility: its laissez faire approach has been extensively implicated not only in the deficiencies of the rating agencies, but in the wider sub-prime crisis.