Feeling Moody about Moody's?

There is definitely a lot of blame to go around for the current financial crisis, where products were judged to be a good investment but have turned out to be seriously flawed. In lite of this, a large portion of the blame must rest with the rating agencies. They gave high ratings to securities that they later had to significantly downgrade. The question then is why were they so wrong?

There seem to be three possible reasons. One, maybe the loss of value was not something that could have been reasonably forecast. I don't believe that this was the reason. It just seems too obvious that many of these securities were more risky then their ratings showed.

Two, a conflict of interest may have influenced their ratings. That there was a conflict seems clear. Moody's for example, is a for-profit enterprise, and its revenue, since the 1970s, comes from the agencies issuing the securities. Therefore, it is in their interest to please the issuers by granting high ratings. The article suggests that as Moody's became more focused on profits, it lost its independence.

Finally, maybe they just didn't do their research, or didn't do it well. The Times article also gets at this, although only briefly:

Even though the standards at many lenders declined precipitously during the boom, rating agencies did not take that into account. The agencies maintained that it was not their responsibility to assess the quality of each and every mortgage loan tossed into a pool.

It seems to me that Moody's failures are a combination of second and third possibilities I mentioned. I imagine though the difference between the first reason and the third reason is whether you think the things they used for the ratings were reasonable. And I argue that it wasn't reasonable. If they weren't assessing the quality of every mortgage what were they using to generate their rating?

The key though is more than just passing blame. There needs to be serious reform. Non-profit rating agencies are one answer. Changing the source of the rating agency's revenue is another - although that doesn't seem like it would work. And definitely improving their methodology is a must. Let's see if the public / politicians have the attention span to do this right.