The Independence Of Credit Rating Agencies

The Independence of Credit Rating Agencies focuses on the institutional and regulatory dynamics of these agencies, asking whether their business models give them enough independence to make viable judgments without risking their own profitability. Few have closely examined the analytical methods of credit rating agencies, even though their decisions can move markets, open or close the doors to capital, and bring down governments. The 2008 financial crisis highlighted their importance and their shortcomings, especially when they misjudged the structured financial products that precipitated the collapse of Bear Stearns and other companies. This book examines the roles played by rating agencies during the financial crisis, illuminating the differences between U.S. and European rating markets, and also considers subjects such as the history of rating agencies and the roles played by smaller agencies to present a well-rounded portrait. Reports on one of the key causes of the 2008 financial crisis: agencies that failed to understand how to analyze financial products Describes inherent business model and pricing conflicts that compromise the independence of credit rating agencies Reveals how rating agencies large and small, regulatory bodies, and vested interests interact in setting fees and policies

Seminar paper from the year 2011 in the subject Business economics - Controlling, grade: 2,0, Rhine-Waal University of Applied Sciences, language: English, abstract: Since the financial crisis in 2008, rating agencies are in the spotlight. Often they were blamed by politicians and economists for causing the crisis, because they rated some financial products with an excellent grade, without exactly knowing what was really behind these products. To understand why and how Credit Rating Agencies like Standard & Poors, Fitch and Moody's rate, we have to look closer at the CRA and their rating in order to understand how they work. In this research paper I will take a critical look at these institutions. I will talk about the independence of these global oriented enterprises and I will analyze their impact on the financial market and the politics in order to demonstrate why they are so powerful like quoted above.

We explore through both an economics and regulatory lens the frictions associated with credit rating agencies in the aftermath of the financial crisis. While ratings and other public signals are an efficient response to scale economies in information production, these also can discourage independent due diligence and be a source of systemic risk. Though Dodd-Frank pulls back on the regulatory use of ratings, it also promotes greater regulation of the rating agencies. We highlight the diverse underlying views towards these competing approaches to reducing systemic risk. Our monograph also discusses the subtle contrasts between credit rating agencies and other types of due diligence providers, such as auditors, analysts and proxy-voting advisors. We discuss the frictions associated with paying for information in the context of credit ratings; while the issuer-pay model has been identified as a major issue because of potential conflict of interests, we argue that it has several advantages over the investor-pay model in promoting market transparency. We develop a formal reputation model to explore the underlying nature of rating inflation and how the reputational trade-off is affected by various aspects of the rating process such as regulatory constraints, the fee structure, asymmetric information between issuers and investors and the extent of competition among rating agencies. The monograph also uses our illustrative framework to highlight tension between rating accuracy and economic efficiency when ratings influence project value in the presence of feedback effects. We discuss how selective disclosure of ratings by the issuer distorts the distribution of observed ratings. Selection also provides an alternative explanation for why solicited (purchased) ratings exceed unsolicited (complimentary) ratings and helps interpret the greater SEC support for unsolicited ratings in recent years as illustrating the theory of the second best. We explore the impact of greater competition on welfare, building upon a variety of frameworks. Our analysis points to several ways in which ratings matter as well as techniques for documenting such effects.

Rating agencies judge how solvent banks and big companies are. Prior to the financial crisis they were too optimistic when rating the risk of the banks and this prompted politicians worldwide to issue new regulations. This book explains what rating agencies do, why they are so important for the economy, and the new European Regulation.

The book examines the role of credit rating agencies (CRAs) in the subprime mortgage crisis. The CRAs are blamed for awarding risky securities ‘3-A’ investment grade status and then failing to downgrade them quickly enough when circumstances changed, which led to investors suffering substantial losses. The causes identified by the regulators for the gatekeeper failure were conflicts of interest (as the issuers of these securities pay for the ratings); lack of competition (as the Big Three CRAs have dominated the market share); and lack of regulation for CRAs. The book examines how the regulators, both in the US and EU, have sought to address these problems by introducing soft law self-regulation in accordance with the International Organisation of Securities Commissions Code and hard law statutory regulation, such as that found in the “Reform Act” and “Dodd-Frank Act” in the US and similar provisions in the EU. The highly topical book examines these provisions in detail by using a doctrinal black-letter law method to assess the success of the regulators in redressing the problems identified. It also examines the US case law regulation relating to the legal liability of CRAs. The book examines whether the regulations introduced have had a deterrent effect on the actions of CRAs, whether investors are compensated for their losses, and how the regulators have dealt with the issues of conflicts of interest and an anti-competitive environment. Should liability be introduced for CRAs through changes in the law so as to compel them to issue reliable ratings and solve the current problems? The book seeks to simplify the complex issues involved and is backed by concrete evidence; as such, it will appeal to both the well-informed and the lay general public who are interested in learning more about the role of CRAs in the sub-prime mortgage crisis and regulators’ attempts to remedy the situation. Novice readers can familiarise themselves with the legal and financial terminology used by referring to the glossary at the end of the book.

The overly optimistic debt ratings provided by credit rating agencies (CRAs) and the lack of transparency about the rating process have been criticized by regulators and pundits for exacerbating the financial crisis. We conduct a mixed-design experiment exploring how two proposals advanced by lawmakers affect the behavior of credit rating analysts. Using data taken from personal lending site Prosper.com, we examine whether (a) the requirement to justify departures from a quantitative model, and (b) conflicts of interests stemming from who pays the analysts affect rating characteristics. We then examine how justifying departures in turn influences the conflicts of interest faced by credit raters. We find that justifying departures reduces the likelihood that credit raters deviate from a quantitative model. Furthermore, credit raters who are not required to justify departures from the model tend to depart from the model in a direction that benefits the borrower, but only in the “borrower pays” condition. Additionally, credit raters facing conflict of interest appear to behave strategically and are less willing to lend their own money to borrowers, even if these credit raters assign more favorable ratings to these same borrowers. This study complements the existing archival literature on credit rating agencies and the conflicts of interest facing these agencies. Results of this study may inform regulators regarding the effectiveness of the different proposals on CRA reform.

Credit rating agencies play an essential role in the modern financial system and are relied on by creditors and investors on the market. In the recent financial crisis, their power and reliability were often questioned, yet a simple rating downgrade could threaten to bankrupt a whole country. This book examines the governance of credit rating agencies, as expressed by their ability to fairly, ethically and consistently assign higher rates to issuers having lesser default risks. However, factors such as the drive for increased revenue and market share, the inadequate business model, the inadequate methodology of assessing risk, opacity and inadequate internal monitoring have all been identified as critical governance failures for credit agencies. This book explores these issues, and proposes some potential solutions and improvements. This will be of interest to researchers and advanced students of corporate finance, finance, financial economics, risk management, investment management, and banking.

Credit rating agencies play a critical role in capital markets, guiding the asset allocation of institutional investors as private capital moves freely around the world in search of the best trade-off between risk and return. However, they have also been strongly criticised for failing to spot the Asian crisis in the early 1990s, the Enron, WorldCom and Parmalat collapses in the early 2000s and finally for their ratings of subprime-related structured finance instruments and their role in the current financial crisis. This book is a guide to ratings, the ratings industry and the mechanics and economics of obtaining a rating. It sheds light on the role that the agencies play in the international financial markets. It avoids the sensationalist approach often associated with studies of rating scandals and the financial crisis, and instead provides an objective and critical analysis of the business of ratings. The book will be of practical use to any individual who has to deal with ratings and the ratings industry in their day-to-day job. Reviews "Rating agencies fulfil an important role in the capital markets, but given their power, they are frequently the object of criticism. Some of it is justified but most of it portrays a lack of understanding of their business. In their book The Rating Agencies and their Credit Ratings, Herwig and Patricia Langohr provide an excellent economic background to the role of rating agencies and also a thorough understanding of their business and the problems they face. I recommend this book to all those who have an interest in this somewhat arcane but extremely important area." -Robin Monro-Davies, Former CEO, Fitch Ratings. "At a time of unprecedented public and political scrutiny of the effectiveness and indeed the basic business model of the Credit Rating industry, and heightened concerns regarding the transparency and accountability of the leading agencies, this book provides a commendably comprehensive overview, and should provide invaluable assistance in the ongoing debate." -Rupert Atkinson, Managing Director, Head of Credit Advisory Group, Morgan Stanley and member of the SIFMA Rating Agency Task Force "The Langohrs have provided useful information in a field where one frequently finds only opinions or misconceptions. They supply a firm base from which to understand changes now underway. A well-read copy of this monograph should be close to the desk of every investor, issuer and financial regulator, legislator or commentator." -John Grout, Policy and Technical Director, The Association of Corporate Treasurers