March 16 (Bloomberg) -- Are the decision makers at Moody's Investors Service stupid or greedy? As uncharitable as that may sound, the rating company's recent misadventures in European bank analysis make it a legitimate question.

Last month, Moody's came up with a whiz-bang new rating method called Joint Default Analysis. It was an attempt to measure the likelihood of government support bailing out a troubled borrower. The new rules produced some bizarre results.

On Feb. 6, Glitnir Banki hf's financial-strength rating was cut by Moody's from C+ to C, the middle of the five-letter scale. Less than three weeks later, Moody's raised Glitnir's overall rating to Aaa -- making Iceland's second-biggest bank as creditworthy as the U.S. government. Kaupthing Bank hf and Landsbanki Islands hf, the nation's biggest and third-biggest banks, were similarly blessed by the Moody's rating wand.

The resulting ridicule that analysts and investors heaped upon the hapless rating company was relentless and thoroughly deserved. On March 9, Moody's announced that it was ``considering refinements to the application of joint default analysis,'' which is public-relations speak for ``we screwed up.''

``At present, Moody's is not commenting beyond its press release,'' wrote London-based spokeswoman Eleanor Childs in an e- mailed response to a request for comment.

There was a slim element of laudable method in Moody's madness. Banks are different from other borrowers, woven more closely into the web of the global financial system. A bankrupt financial company could trigger systemic repercussions in ways that a bankrupt metal-bashing company can't.

Lampooned in Video

It is a step too far to suggest that bank bondholders are assured of a government bailout. To a man with a hammer, though, everything looks like a nail. Once Moody's had fashioned itself a new hammer, it seems it couldn't resist banging in the pins, even after realizing its new system would produce absurdly high ratings for Iceland's banks.

Someone has gone to the trouble of producing mini-videos mocking the situation and posting them on the Internet. ``I let you out of my sight for 10 seconds and you give out AAA to the Icelanders,'' says a guy in a turban. ``You were just meant to boost fees and get more CDO business.''

There's more than a grain of truth in that little jest about collateralized debt obligations, known as CDOs. On March 13, for example, Moody's shares dropped as much as 6.5 percent on concern the rise in subprime mortgage defaults would crimp the market for new CDOs, hurting fee income for rating companies. Shares of McGraw-Hill Cos., the owner of Standard & Poor's, declined by as much as 2.7 percent.

Pay to Play

The rating companies are scrapping for market share in a business with a built-in bias. Anyone who makes and sells bonds for a living will pay whichever rating company is likely to give their products the highest grade.

So the intellectual honesty of delivering a true assessment of creditworthiness conflicts with the commercial imperative to win business. And whenever one of the rating companies tweaks its methodology, it always seems to result in higher grades, never lower assessments.

The solution -- removing as much commerce as possible from the equation to ensure the purity of rating assessments -- is easier to outline than to achieve. Investors, capitalist red in tooth and claw, are unlikely to accept a government agency as a replacement. There's little enthusiasm for a subscriber-only revenue model, which is how Sean Egan at Haverford, Pennsylvania- based Egan-Jones Ratings Co. funds his business.

Rating the Raters

It doesn't help that the rating companies are unloved. There's a sneaking suspicion that if their analysts were any good, they would be earning megabucks scrutinizing borrowers for the likes of Goldman Sachs Group Inc.

And their failure to anticipate corporate collapses such as Parmalat SpA and Enron Corp. raises the distinct possibility that the snapshots they give of a borrower's creditworthiness are hopelessly out of date.

At the beginning of last month, for example, New Century Financial Corp. had a Standard & Poor's grading of BB and was defined by the rating company as ``less vulnerable in the near term than other lower-rated obligors.''

Since then, S&P has cut its judgment on the company five times -- with four of those reassessments coming in the first 12 days of this month -- dragging its rating of the second-biggest U.S. subprime mortgage lender down to D for default. All of which is a bit late for New Century investors, who have watched its stock plummet to less than $1.30 from more than $30 at the end of last year.

As well as helping bond investors gauge the amount of risk in their holdings, credit ratings dictate the cost of money for thousands of borrowers. Ratings are almost too important to be entrusted to the rating companies.

One of the Internet video spoofs features a small girl saying ``I'm only 6 and I don't believe in Santa or Moody's anymore.'' Stupid or greedy? Rating companies might be both.

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Mark Gilbert in London at magilbert@bloomberg.net

Last Updated: March 15, 2007 20:11 EDT