The controversies credit rating agencies face: Part 1
The 2008 crisis, the monopoly accusations and the payment model that have casted doubt on the credibility of credit rating agencies.
By: Ximena Peinado
Credit rating agencies have a potent underestimated power: with their ratings, they can strongly influence an investor’s perception of a company’s or government’s creditworthiness.
A series of mistakes have been made and these agencies have been accused of being politically biased, having a bad methodology, giving out false ratings and making it possible for people to buy the ratings of their securities.
The agencies aim is to provide investors with reliable information on debt risks. Nonetheless, they have been accused several times of making the financial crisis worse. ¿Could that be true?
The 2008 crisis
In 2008, during the financial crisis and the Great Recession (2007 to 2009), credit bureaus were accused of misinterpreting risks and giving overly positive (AAA) ratings to mortgage-related securities, which led to poor decision making by investors who had been convinced of low-risk investment.
This is how the agencies were accused of trying to increase their profits and their market share in exchange for these poor ratings.
In 2007, when home prices began to fall, Moody’s downgraded 83 per cent of the 869 billion dollars in mortgage securities it had previously rated AAA in 2006.
In past chapters, we have commented how the three main New York agencies (Standard and Poor’s , Moody’s and Fitch Ratings) control 90 percent of the entire market and only Fitch Ratings controls 15 percent of it. This argument is not helped by the fact that these three were the only credit rating agencies approved by the Securities Commission (SEC) in the United States until 2003.
Today, in the United States the ‘Dodd-Frank’ law forces the SEC to evaluate active credit bureaus each year and remove approval from those that have produced wrong ratings. Still, the Big Three have never been removed from that list, despite publicly facing other issues that we’ll talk about below.
Another group that also came out against the credit agencies during 2008 was the European Union, China and South Africa, which after the crisis changed their laws to fix the problems that the operations of the credit agencies brought with them.
This happened because of the ‘junk’ ratings they issued from high-risk countries such as Greece, Portugal and Ireland in those difficult economic years. The April 2010 decision to downgrade Greece’s debt to junk-level, for example, weakened investor confidence, raised the cost of borrowing, and made the financial rescue package inevitable in May 2010.
The agencies also lowered the credit ratings of France, Austria and other leading countries in the European Union. According to Union officials, these changes accelerated the Eurozone sovereign debt crisis, leading to the creation of an independent European rating agency.
Additionally, in January 2012 the agencies lowered their rating to nine countries and left only Germany with the best rating (AAA). In 2013, they lowered the ratings across Europe, which ignited protests from Union officials who objected that the budget reforms were evidence that they could meet their financial commitments.
Keep learning with PR1ME Capital
Previously we discovered the origin, evaluation procedures and competitive differences of the Risk Rating Agencies and we understood that for companies, having a good rating is vital in order to find new investors who want to give a part of their capital to the development of the organization.
With the necessary information, the agencies carry out an exhaustive analysis of the key factors for the rating , such as financial reports, information from the private and public sector and the company’s performance over long periods.
Now we know that there are more than a hundred other rating agencies at the international level , 118 of which are currently active; of these, only nine are approved and recognized by the US Securities and Exchange Commission.
The following week we will address other controversial issues such as the preference for the United States and criticism of the payment model that they keep in business to continue standing.
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