Ambac Ditches Fitch, Undermines Entire Ratings System

(MoneyWatch)  The tortured love affair between the ratings agencies and the bond insurers took another turn as Ambac Financial Group resolved to terminate its contract with Fitch Ratings. While Ambac is not the first insurer to give a rating agency the Heisman -- not always successfully -- its ability and willingness to do so puts the entire rating system in question.

There was a time when bond insurers loved the rating agencies. Indeed, if not for the ménage-a-trois between the raters, the insurers, and the issuers of mortgage-backed securities, the entire credit boom (now bust) would scarcely have been possible. The rating agencies scored bonds backed by dubious mortgages as entirely credit-worthy, sometimes on their own, and sometimes because the bonds were backed by the likes of Ambac and MBIA. Dubious credit turned to gold.

The more general conflict of interest where rating agencies "work with" investment banks before rating their issues -- thereby allowing the banks to shop for the best rating -- has already drawn the attention of the SEC.

Lately, though, the insurers have developed their own credit problems, leading the rating agencies to deny them triple-A status. Some have argued they are headed for bankruptcy. Now insurers like Ambac are saying that if they can't get the best grade, they might as well drop the course. But if a company, whether an insurer or any other kind, can simply opt out of the system, exactly what value do the ratings have in the first place?