Credit Rating Agencies – Need For Reform

1. Crisis – Spotlight on Credit Rating Agencies

“Credit-rating agencies utilize their control of information to trick investors into believing that a pig is a cow and a rotten egg is a roasted chicken. Collusion and misrepresentation are not elements of a genuinely free market ” – US Congressman Gary Ackerman

The smooth functioning of global financial markets depends, in part, upon reliable assessments of investment risks, and Credit Rating Agencies play a significant job in boosting investor confidence in those markets.

The above rhetoric, although harsh, beckons us to zero in our focal point on the functioning of credit rating agencies. Recent debacles, as enunciated below, make it all the more important to scrutinize the claim of Credit Rating Agencies as fair assessors.

I) Sub-Prime Crisis: In the recent sub-prime crisis, Credit Rating Agencies have come under increasing fire for their covert collusion in favorably rating garbage CDOs in the sub-prime mortgage business, a crisis which is currently having world-wide implications. To give some background, loan originators were guilty of packaging sub-prime mortgages as securitizations, and marketing them as collateralized debt obligations on the secondary mortgage market. The agencies failed in their duty to warn the financial Best PR Agency in Canada world of this malpractice through a fair and transparent assessment. Shockingly, they gave favorable ratings to the CDOs for reasons that should be examined.

ii) Enron and WorldCom: These companies were rated investment grade by Moody’s and Standard and Poor’s three days before they went bankrupt. Credit Rating Agencies were alleged to have favorably rated risky products, and in some instances put these risky products together for a fat expense.

There may be other over-rated Enron’s and WorldCom’s waiting to go bust. The agencies should be reformed, to enable them pin-point such cancer well-in-advance, thereby increasing security in the financial markets.

2. Credit Ratings and Credit Rating Agencies

I) Credit rating: is a structured methodology to rank the creditworthiness of, broadly speaking, an entity, or a credit commitment (for example a product), or a debt or debt-like security as also of an Issuer of an obligation.

ii) Credit Rating Agency (CRA): is an institution, specialized in the work of rating the above. Ratings by Credit Rating Agencies are not recommendations to purchase or sell any security, but just an indicator.