How The U.S. Gave S&P Its Power : Planet Money The government gave rating agencies a special position in the financial system. "There's some ironies, shall we say, in all of this," a professor says.
NPR logo

How The U.S. Gave S&P Its Power

  • Download
  • <iframe src="" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
  • Transcript
How The U.S. Gave S&P Its Power

How The U.S. Gave S&P Its Power

  • Download
  • <iframe src="" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
  • Transcript

MELISSA BLOCK, host: From NPR News, this is ALL THINGS CONSIDERED. I'm Melissa Block.

MICHELE NORRIS, host: And I'm Michele Norris.

On Friday, the rating agency Standard and Poor's downgraded the United States. By Monday, the stock market was in freefall. S&P insists it's simply pointing out the obvious problems with U.S. debt and government gridlock. But the process highlights how private companies like rating agencies can shake nations with nothing more than a press release.

Robert Smith from NPR's Planet Money team has a short history of how the rating agencies got so much influence.

ROBERT SMITH: Just who gave Standard and Poor's the power, the muscle to kick sand in the face of the U.S. government? Oh yeah, it was the U.S. government itself.

LAWRENCE WHITE: There's some ironies, shall we say, in all of this.

SMITH: Professor Lawrence J. White, from the NYU Stern School of Business, says you have to go back a hundred years to see exactly how it happened. In fact, you have to go to the big tech bubble of the 1800s.

WHITE: Railroads.

SMITH: The rating agencies that now make grown investment bankers tremble were once a bunch of railroad geeks.

WHITE: There were a lot of railroads out there and investors wanted to know, so who were guys who are likely to pay me back?

SMITH: And who are the criminals who will take my money on a one-way trip out West? Enter the unfortunately named Henry Varnum Poor. Yes, he's the second half of Standard and Poor's. In 1860, he published a giant book of nothing but financial details of railroads. Finally, there was a way to start to make sense of the industry.

In 1909, another famous name, John Moody, would jump into the railroad reporting business too. He was the first one to use those letter grades. He was followed by Fitch. Standard joined up with Poor. Professor White says all the names you might know in the rating business today got started back then.

WHITE: By the 1920s, the stock market is booming. So, there's this need for more and more information on the part of lenders - who is a good risk, who is not?

SMITH: But back then, the rating of a loan was just a service that investors paid for. It didn't have the make-or-break power that it has today. The U.S. government changed all that.

After the stock market crash of 1929 and the start of the Depression, the U.S. government started to regulate the health of the banks. And they said if you're going to hold bonds of railroads or any other company, they have to be of good quality. But here's the catch - White says the bonds had to be rated by one of these private agencies.

WHITE: It was outsourced. It was delegated to this handful - literal, handful - of third-party private sector rating firms.

SMITH: We might never have heard of Standard or Poor or Moody if the U.S. government hadn't enshrined them really with a special status. Private businesses but also serving this public function of validating debt.

Now, Professor White says that they were pretty good at their jobs. Historical analysis shows that rating agencies generally were right on separating the good loans from the bad. But the business started to change in the late 1960s. Instead of charging investors, the rating agencies started to take money from the issuers of the bonds - from the people they were judging.

And Professor White blames the Xerox.

WHITE: High-speed photocopy machine, no question.

SMITH: The ratings agencies were afraid, he says, that investors would just pass around their information for free. So they had to start making money from the company side. Even this seemed to work for years, until the big scandals of the last decade. The rating agencies missed Enron's impending bankruptcy. Then they rated too many of those subprime mortgage securities as Triple-A.

Congress even passed legislation ordering regulators to stop relying on the rating agencies as much as they used to. But after all these years, it's hard to undo decades of special status. And now the U.S. government finds themselves facing a downgrade from one of the very agencies it empowered in the first place.

Robert Smith, NPR News, New York.

Copyright © 2011 NPR. All rights reserved. Visit our website terms of use and permissions pages at for further information.

NPR transcripts are created on a rush deadline by Verb8tm, Inc., an NPR contractor, and produced using a proprietary transcription process developed with NPR. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.