Underrated: S&P, Moody's, Fitch ... and PIMCO

It's been a tough week for the big three rating agencies: Standard & Poor's, Moody's Investors Service, and Fitch Ratings, which seem to be following in the footsteps of the big three auto makers.

First the National Association of Insurance Commissioners put up a "No Help Wanted" sign; at least as far as they were concerned. After a semi-secret bidding contest, the NAIC announced that it had anointed PIMCO, the big bond firm with more than $900 billion under management, as the arbiter of value for more than $145 billion of residential mortgage-backed securities that insurers hold in their portfolios.

To make matters worse, yesterday Ohio Attorney General Richard Cordray slammed the three big raters with a lawsuit, charging them with costing the Buckeye State $457 million by giving their seal of approval to what turned out to be high-risk securities that subsequently went bust in the real estate collapse.

Cordray will attack the rating agencies' defense that they have the First Amendment right to freedom of speech and can say something, even if it's wrong, by claiming in effect that they are journalists.

But journalists should not take money from the subjects of their stories, while S&P, Moody's and Fitch use a business model where companies pay them to rate their bonds. "Credit rating agencies, in exchange for fees, departed from their objective, neutral role," Cordray claims, selling their integrity to the highest bidder. As the New York Times points out, other state attorneys general have already filed suit against the raters, or are considering it.

This should make PIMCO a little wary about "winning" the NAIC contest. Already the NAIC method of selection has been called into question by the Consumer Federation of America and its insurance advocate, former Texas Insurance Commissioner J. Robert Hunter, who is calling on the NAIC to make public the other 10 applicants for the job.

The Wall Street Journal also weighed in, noting that PIMCO, which is itself owned by the German insurer Allianz SE, may have a conflict of interest, particularly if rating bonds owned by Allianz. PIMCO also has a lot of mortgage bonds in its portfolio, some of which were bought from the Federal Reserve and, as the Journal points out, PIMCO's ratings could help - or hurt - its own investments.

There may be no viable solution to rating these bonds, but that won't stop the attorneys general from filing suit. At least the lawyers will make money.