In the US, ratings agencies and the bond rating system are a legacy of the New Deal-- the ratings agencies are approved by federal regulators and are protected from real competition.
Contrast that with stocks, where anybody can be an analyst and issue a rating, and where there is no mechanical, legalistic system of downgrades and upgrades.
The feds created the bond ratings agency oligopoly to "protect investors", but I'd argue we'd be better served by true ratings competition and more due diligence by investors.
I think that it's a de-facto monopoly in that if you set up your own bond rating agency, nobody would be compelled by law to only invest in things that your rating agency considered "investment grade".
That's right. The ratings agencies sit at a critical junction in the American (and global system) so when they fail, or have mixed incentives, the whole system breaks, which is a major part of the story of 2008.
It wasn't always that way. There's a Planet Money podcast covering how the ratings agencies came to be and how thet got their legal significance. Interesting story.
These days it is a bit more complicated. Now just about anyone sensible can become a "blessed" agency, a Nationally Recognized Statistical Rating Organization (NRSRO).
The catch is that the biggest rating agencies accept payments by the company issuing the bond. What happens is that Bank of Insanity gives Moody's a check for $500k to rate their super-senior diseased livestock bond. Moody's then says "at least 5% of the cows will probably survive, and $500k is a lot of money, so this bond is investment grade!"
Contrast that with stocks, where anybody can be an analyst and issue a rating, and where there is no mechanical, legalistic system of downgrades and upgrades.
I think this statement is a little stronger than is accurate. For a time I was on the career path of a stock analyst, and before my name could be on any notes urging investors to buy or sell, I had to take and pass a number of licensing tests: Series 7, 63, 86, and 87. These tests were mandated and run by FINRA, as ordered by the SEC.
So not just "anybody" can issue a rating.
However, I understand your larger message that there aren't larger legal implications surrounding your rating; other than simple anti- market manipulation type things.
Bond rating agencies are superfluous when it comes to liquid bonds such as US Treasuries. The only reason their ratings have any impact right now is because of outdated SEC rules related to Nationally Recognized Statistical Rating Organizations.
http://www.sec.gov/answers/nrsro.htm
The market itself is a better judge of future value than any more-or-less arbitrary rating by S&P or one of its competitors.
The bond raters do still add some value by evaluating new issues or thinly traded securities. In those cases the markets don't give us useful information.
You don't understand the legal structures here. Of course there are rules, but there's no competitive barrier to entry to the stock analysis business. There are thousands of companies that provide stock research, but only a handful of official bond ratings companies. And there's an entire legal and regulatory structure around bonds and bond ratings, which does not exist around equities, and which connect bond ratings to the US banking, pension, and insurance systems. Here's a good overview of the debate on ratings agency reform: http://www.sec.gov/rules/concept/33-8236.htm
Contrast that with stocks, where anybody can be an analyst and issue a rating, and where there is no mechanical, legalistic system of downgrades and upgrades.
The feds created the bond ratings agency oligopoly to "protect investors", but I'd argue we'd be better served by true ratings competition and more due diligence by investors.