The Wall Street Journal reports that regulation aimed at improving rating quality has instead likely hurt it - competition has led challengers to rate the same bonds higher than major firms are. These inflated prices are causing a ripple effect for investors who are holding riskier than they were originally led to believe.
Behind the ratings inflation is a long-acknowledged flaw Washington didn’t fix: Entities that issue bonds—state and local governments, hotel and mall financiers, companies—also pay for their ratings. Issuers have incentive to hire the most lenient rating firm, because interest payments are lower on higher-rated bonds. Increased competition lets issuers more easily shop around for the best outcome.