Why the Ratings Agencies Flunked

Moody's, the only publicly traded ratings firm, posted net income of $705 million in 2006, up 343% from the $159 million it reported in 2000. That gain stems largely from increased fees from the "structured finance" products that are now at the root of the credit crisis. Meanwhile, it boasts some 9,300 customer accounts at 2,400 institutions around the globe and has more than 1,000 analysts.

Ackman says it's tough to support a sizable ratings business while being paid only by investors, because once a bond is determined to be Triple-A, everyone can use that rating without paying for it.

"What they should do is charge the issuers a few basis points on every bond for the ratings and those funds should go into a pool to pay firms that provide ratings," says Ackman. "Investors should determine how those funds get allocated on an annual basis by using surveys to select firms with the best track record."

Egan points out that the major credit ratings agencies all survived for more than a half-century on fees paid by investors. It wasn't until the 1970s that they shifted their business to issuer-backed models.

"Our business model makes a lot of sense and it has worked beautifully in the past," says Egan. "Eventually, ratings firms should be weaned from issuer compensation if they're going to be considered designated ratings firms by the SEC."