Maybe Moody’s (MCO) should have thought of this before. According to the FT, Moody’s is considering overhauling the way it rates complex financial instruments to analyse how these products might behave in a liquidity shock. Right now, Moody’s only looks at default risk. The new rating would look at what happens to the value of an instrument if it is in a market with little or no liquidity.

Management at the company made this comment “The sudden lack of liquidity due to the lack of transparency is currently the biggest problem in the market – can we develop a product that speaks to this risk? It is something we are certainly working on.”

But, what is lack of liquidity? How much does a market needs to seize up before an instrument loses 10% or its value? How about 50%? How long does the market have to be illiquid before its drives down the price of a participating security?

Can this kind of analysis be done? Probably, but most likely any ratings of this type will come with 100 pages of qualifications.

And, it is a little late in the game for Moody’s  Conderns about how it rates securities, how it gets paid for the ratings, and how accurate they are have taken MCO’s shares from a 52-week high of $76 to under $43.

The big threat that Moody’s faces now is not whether it does a good job of offering a broad spectrum of market analysis. It is not whether Moody’s opinions were wrong. That is probably protected under the "free speech" privision of the Constitution.

The big issue is whether Moody’s rating things diffrently than it might have based on how it was paid. And, that is a big issue.

Douglas A. McIntyre

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