It is not that long ago that the role of ratings agencies was reappraised by the Securities and Exchange Commission (SEC) in the aftermath of the failure of Enron in 2001. The Sarbanes-Oxley Act specifically directed the SEC to examine, amongst other items, the role of the rating agencies in the functioning of the securities markets, the accuracy of their ratings, and any conflicts of interest that may hinder their watchdog role in the economy. A result of this reappraisal was the enactment of the Rating Agency Reform Act in 2006.

A scant two years later, we are in the same position, once again reappraising the role of rating agencies. Then, we were concerned about their corporate ratings. Now, we are concerned about the ratings of structured products. And once again we have new regulations on the rating agencies. Will this, finally, solve the problems associated with the ratings agencies?

The simple answer is `No'. To understand why, it is first useful to understand the role of the agencies in the current crisis. The rating agencies gave high ratings to structured products issued by investment banks. In doing so, the agencies used the same rating scale for structured products that they use for corporate debt, implying that an identical rating for a corporate debt offering and a securitized product meant identical rating transitions and default probabilities.

Did these structured products behave like corporate debt? In the absence of fraud, non-financial AAA corporate debt should not be downgraded to junk within a year or two of issuance. But this is exactly what has happened with a number of the top-rated tranches of structured products.

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