Dignity loves company
When times were good (before this year, I guess), the denizens of credit-ratings agencies like Moody's (NYSE:MCO) and McGraw Hill's (NYSE:MHP) Standard & Poor's were treated with dignity -- or at least with big salaries and nice stock gains. After all, the new biz of rating mortgage-backed securities had given the firms a major boost. Now, things are ugly in the mortgage market: The risk, it turns out, was only obscured, not removed, not even by the umpteen iterations of slicing and dicing.

No amount of MBS, MBA, CDO, OMG, or BBQ could remove the toxicity completely. In fact, it may only have made things worse by some measure, as hedge funds, banks, and other holders of these bonds finally came to realize that they had little idea how much risk they were buying, selling, and holding. As a result, the entire house of cards based on mortgage-backed securities collapsed, nearly completely. Like the end of a heist film, no one trusted anyone else. So lending ground to a halt until the European Central Bank and the Fed stepped in a few weeks back. Of course, politicians and the public are demanding answers (if not heads on platters), so it's time for the ratings agencies to submit to some probing.

Under the magnifying glass
An article in today's Wall Street Journal describes the breadth of the upcoming government probulation of Wall Street's recently fallen darlings. The attorneys general of New York and Ohio are sniffing the waters for blood, and the SEC is taking a look, too. And, of course, a couple of Senate committee grillings will allow Johnny-come-lately politicians (who, of course, said little or nothing about the dangers of the housing bubble while it was inflating) to feign outrage at some of the alleged guilty parties.

If, like millions of other Americans with an ounce of common sense, you're wondering just how Wall Street managed to package pools of low-quality loans (subprime, "Alt-A," option-ARMs, etc.) into groups, then somehow pretend that a portion of that stuff was A-list debt, we may be about to find out, in detail. The probes will hinge on the question of whether or not there were any conflicts of interest that may have thrown a rose-hued tint over the peepers of the people responsible for rating these bonds.

I'm not sure you need to look for something as outwardly sinister-sounding as that. Good old-fashioned greed and ignorance are probably more than enough to have scaled their eyes.

Is profit a conflict of interest?
If you're running a credit-rating company or you're just a cube-jockey in the trenches and you want to keep the volume rolling, and you know that bond issuers want the highest ratings they can get for their products, and you've seen your salary soar as this business has boomed, aren't you going to try and keep the clients happy? Come on, be a team player!

And if you don't exactly know just how bad things might turn out with this debt, and nothing bad has happened so far, aren't you going to give the clients' paper the benefit of the doubt? The team needs you, Mr. Anderson! Play ball! Besides, we can always downgrade them later, if, by some completely unforeseeable happenstance, it turns out that Cletus and Brandeen can't afford that 4,000 square foot McMansion (nor their Florida "investment" condo) after their option-ARMs reset, right?

Another interesting possibility noted by that WSJ article: If you're an individual analyst looking at some opaque gob of Bumpkaloosa debt, pooled, sliced, and diced by Citigroup (NYSE:C), Bear Stearns (NYSE:BSC), Lehman Brothers (NYSE:LEH), Morgan Stanley (NYSE:MS), or Goldman Sachs (NYSE:GS), are you really going to risk your prospects at a prospective future employer by being too harsh on their bonds? What those Hedgies, Chinese bond buyers, or European Banks' "conduit" entities don't know can't hurt you, right?

Foolish final thought
The rumor mills have been grinding on this issue for some time since mortgages started to blow up, with the most egregious (but simple, and therefore believable) charges I've read being that the ratings agencies -- not knowing how to rate the credit of these fancy new financial instruments -- simply adopted the model provided to them by the banks who did the packaging and issued the bonds.

Yeah, my Mom says I'm handsome, too. How much money would you bet on her being right?

Moody's is a Motley Fool Stock Advisor recommendation and is up 125% since it was first recommended in 2002.

At the time of publication, Seth Jayson, a top-10 CAPS player, had no shares of any company mentioned here. See his latest CAPS blog commentary here. View his stock holdings and Fool profile here. Fool rules are here.