Credit rating agency

1283:, the company's ratings remained at investment grade until four days before bankruptcy—though Enron's stock had been in sharp decline for several months—when "the outlines of its fraudulent practices" were first revealed. Critics complained that "not a single analyst at either Moody's or S&P lost his job as a result of missing the Enron fraud" and "management stayed the same". During the subprime crisis, when hundreds of billion of dollars' worth of triple-A-rated mortgage-backed securities were abruptly downgraded from triple-A to "junk" status within two years of issue, the CRAs' ratings were characterized by critics as "catastrophically misleading" and "provided little or no value". Ratings of preferred stocks also fared poorly. Despite over a year of rising mortgage delinquencies, Moody's continued to rate 1502:", each with a different priority of payment. Tranches are often likened to buckets capturing cascading water, where the water of monthly or quarterly repayment flows down to the next bucket (tranche) only if the one above has been filled with its full share and is overflowing. The higher-up the bucket in the income stream, the lower its risk, the higher its credit rating, and lower its interest payment. This means the higher-level tranches have more credit worthiness than would a conventional unstructured, untranched bond with the same repayment income stream, and allows rating agencies to rate the tranches triple A or other high grades. Such securities are then eligible for purchase by 1039:, expected loss, or a similar metric. The metrics vary somewhat between the agencies. S&P's ratings reflect default probability, while ratings by Moody's reflect expected investor losses in the case of default. For corporate obligations, Fitch's ratings incorporate a measure of investor loss in the event of default, but its ratings on structured, project, and public finance obligations narrowly measure default risk. The process and criteria for rating a convertible bond are similar, although different enough that bonds and convertible bonds issued by the same entity may still receive different ratings. Some bank loans may receive ratings to assist in wider 1390:: not only do interest rates on securities rise, but other contracts with financial institutions may also be affected adversely, causing an increase in financing costs and an ensuing decrease in creditworthiness. Large loans to companies often contain a clause that makes the loan due in full if the company's credit rating is lowered beyond a certain point (usually from investment grade to "speculative"). The purpose of these "ratings triggers" is to ensure that the loan-making bank is able to lay claim to a weak company's assets before the company declares 1190:

bond). However, some studies have estimated the average risk and reward of bonds by rating. One study by Moody's claimed that over a "5-year time horizon", bonds that were given its highest rating (Aaa) had a "cumulative default rate" of just 0.18%, the next highest (Aa2) 0.28%, the next (Baa2) 2.11%, 8.82% for the next (Ba2), and 31.24% for the lowest it studied (B2). (See "Default rate" in "Estimated spreads and default rates by rating grade" table to right.) Over a longer time horizon, it stated, "the order is by and large, but not exactly, preserved".

105: 733:(SEC). In 1936, regulation was introduced to prohibit banks from investing in bonds determined by "recognized rating manuals" (the forerunners of credit rating agencies) to be "speculative investment securities" ("junk bonds", in modern terminology). US banks were permitted to hold only "investment grade" bonds, and it was the ratings of Fitch, Moody's, Poor's, and Standard that legally determined which bonds were which. State insurance regulators approved similar requirements in the following decades. 3136:

had to calculate the statistical probabilities that certain kinds of mortgages might default, and to estimate the revenues that would be lost because of those defaults. Then investors had to determine the effect of the losses on the payments to different tranches. This complexity transformed the three leading credit rating agencies—Moody's, Standard & Poor's (S&P), and Fitch—into key players in the process, positioned between the issuers and the investors of securities.

36: 1673:, and sovereign-supported international entities. Sovereign borrowers are the largest debt borrowers in many financial markets. Governments from both advanced economies and emerging markets borrow money by issuing government bonds and selling them to private investors, either overseas or domestically. Governments from emerging and developing markets may also choose to borrow from other government and international organizations, such as the 1571:(CDOs). These securities mortgage/asset backed security tranches lower in the "waterfall" of repayment that could not be rated triple-A, but for whom buyers had to be found or the rest of the pool of mortgages and other assets could not be securitized. Rating agencies solved the problem by rating 70% to 80% of the CDO tranches triple-A. Still another innovative structured product most of whose tranches were also given high ratings was the " 679:

the fact that merchants knew their customers personally and knew whether or not they would be able to pay them back. As trading distances increased, merchants no longer personally knew their customers and became wary of extending credit to people who they did not know in fear of them not being able to pay them back. Business owners' hesitation to extend credit to new customers led to the birth of the credit reporting industry.

7326:" (Reuters) - Credit ratings organisations from five countries are launching a new global agency, touting it as an alternative to the Big Three agencies which they say no longer meet the needs of the new globalised world. In a statement on Tuesday, ARC Ratings said the agency would launch in London as a joint venture between CPR of Portugal, CARE Rating of India, GCR of South Africa, MARC of Malaysia, and Brazil's SR Rating." 4744:

City, the bankruptcy of Orange County, and the Asian and Russian meltdowns. They failed to catch Penn Central in the 1970s and Long-Term Capital Management in the 1990s. They often downgraded companies just days before bankruptcy – too late to help investors. Nor was this anything new: one study showed that 78% of the municipal bonds rated double A or triple-A in 1929 defaulted during the Great Depression.

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This is what Goldman Sachs had cleverly done. it was absurd. The 100 buildings occupied the same floodplain; in the event of flood, the ground floors of all of them were equally exposed. But never mind: the rating agencies, who were paid fat fees by Goldman Sachs and other Wall Street firms for each deal they rated, pronounced 80% of the new tower of debt triple-A." (source: Michael Lewis,

2106:, because barriers to market entry are high and rating agency business is itself reputation-based (and the finance industry pays little attention to a rating that is not widely recognized). In 2003, the US SEC submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest. 695:

to finance them, and therefore a bond market several times larger than in other countries. The bond markets in the Netherlands and Britain had been established longer but tended to be small, and revolved around sovereign governments that were trusted to honor their debts. Companies were founded to provide investors with financial information on the growing railroad industry, including

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paid lip service to compliance. In one case, an agency had issued an annual compliance report only a single page in length, with scant discussion of methodology. In another case, a chief executive officer of a company had signed off on a report as though a board member. Also, overseas staff of ratings agencies had assigned credit ratings despite lacking the necessary accreditation.

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do that because you know the people that we were selling these bonds to had never really had any history in the mortgage business. ... They were looking for an independent party to develop an opinion," Jim Callahan told the FCIC; Callahan is CEO of PentAlpha, which services the securitization industry, and years ago he worked on some of the earliest securitizations

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Department of Labor restricts pension fund investments to securities rated A or higher. Credit ratings affect even private transactions: contracts may contain triggers that require the posting of collateral or immediate repayment, should a security or entity be downgraded. Triggers played an important role in the financial crisis and helped cripple AIG.

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Moody's and Fitch control 98 percent of the market for debt ratings in the U.S., according to the SEC. The noncompetitive market leads to high fees, says SEC Commissioner Casey, 43, appointed by President George W. Bush in July 2006 to a five-year term. S&P, a unit of McGraw-Hill Cos., has profit margins similar to those at Moody's, she says.

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bondholders, lawyers and even regulators are quick to rush the field to protest the credit analyst's lapse." Others say that bonds assigned a low credit rating by rating agencies have been shown to default more frequently than bonds that receive a high credit rating, suggesting that ratings still serve as a useful indicator of credit risk.

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publish ratings for that purpose. Governing bodies at both the national and international level have woven credit ratings into minimum capital requirements for banks, allowable investment alternatives for many institutional investors, and similar restrictive regulations for insurance companies and other financial market participants.

5382: 833:. Moody's and S&P opened offices Europe, Japan, and particularly emerging markets. Non-American agencies also developed outside of the United States. Along with the largest US raters, one British, two Canadian and three Japanese firms were listed among the world's "most influential" rating agencies in the early 1990s by the 903:

Markets as the private-sector group to provide the PWG with industry recommendations on credit rating matters. It published the "Recommendations of the Securities Industry and Financial Markets Association Credit Rating Agency Task Force", which included a dozen recommendations to change the credit rating agency process.

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between debt issuers and investors. Hence, CRAs provide an independent evaluation and assessment of the ability of issuers to meet their debt obligations. In this way, CRAs provide 'information services' that reduce information costs, increase the pool of potential borrowers, and promote liquid markets.

1734:(IOSCO) published a Code of Conduct for CRAs that, among other things, is designed to address the types of conflicts of interest that CRAs face. All of the major CRAs have agreed to sign on to this Code of Conduct and it has been praised by regulators ranging from the European Commission to the US SEC. 1202:" (or 43/100ths of a percentage point) more than a Treasury bond (so that it would yield 3.43% if the Treasury bond yielded 3.00%). A CCC-rated "junk" (or speculative) bond, on the other hand, paid over 4% more than a Treasury bond on average (7.04% if the Treasury bond yielded 3.00%) over that period. 3319:

Critics say this created perverse incentives such that at the height of the credit boom in 2005 to 2007, the agencies recklessly awarded Triple A ratings to complex exotic structured instruments that they scarcely understood. They have profited handsomely. In the three-year period ending in 2007, the

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Moody's, the only one of the three that stands alone as a publicly traded company, has averaged pretax profit margins of 52 percent over the past five years. It reported revenue of $ 1.76 billion – earning a pretax margin of 41 percent – even during the economic collapse in 2008. S&P,

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Purchasers of the safer tranches got a higher rate of return than ultra-safe Treasury notes without much extra risk—at least in theory. However, the financial engineering behind these investments made them harder to understand and to price than individual loans. To determine likely returns, investors

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Credit ratings also determined whether investors could buy certain investments at all. The SEC restricts money market funds to purchasing "securities that have received credit ratings from any two NRSROs ... in one of the two highest short-term rating categories or comparable unrated securities." The

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The extensive use of credit ratings for regulatory purposes can have a number of unintended effects. Because regulated market participants must follow minimum investment grade provisions, ratings changes across the investment/non-investment grade boundary may lead to strong market price fluctuations

1754:

Regulatory authorities and legislative bodies in the United States and other jurisdictions rely on credit rating agencies' assessments of a broad range of debt issuers, and thereby attach a regulatory function to their ratings. This regulatory role is a derivative function in that the agencies do not

902:

formed a global task force with members drawn from a cross-section of the financial services industry, including asset managers, underwriters, and issuers, and provided industry input to lawmakers and regulators in Europe and Asia, and was designated by the U.S. President's Working Group on Financial

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corporations. Rating agencies also began to apply their ratings beyond bonds to counterparty risks, the performance risk of mortgage servicers, and the price volatility of mutual funds and mortgage-backed securities. Ratings were increasingly used in most developed countries' financial markets and in

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More debt securities meant more business for the Big Three agencies, which many investors depended on to judge the securities of the capital market. US government regulators also depended on the rating agencies; they allowed pension funds and money market funds to purchase only securities rated above

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Participants in the securitization industry realized that they needed to secure favorable credit ratings in order to sell structured products to investors. Investment banks therefore paid handsome fees to the rating agencies to obtain the desired ratings. "The rating agencies were important tools to

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SEC Commissioner Kathleen Casey has said that these CRAs have acted much like Fannie Mae, Freddie Mac and other companies that dominate the market because of government actions. When the CRAs gave ratings that were "catastrophically misleading, the large rating agencies enjoyed their most profitable

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Of the large agencies, only Moody's is a separate, publicly held corporation that discloses its financial results without dilution by non-ratings businesses, and its high profit margins (which at times have been greater than 50 percent of gross margin) can be construed as consistent with the type of

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report proposed a "hybrid" approach in which issuers who pay for ratings are required to seek additional scores from subscriber-based third parties. Other proposed alternatives include a "public-sector" model in which national governments fund the rating costs, and an "exchange-pays" model, in which

1835:

As of December 2012, S&P is the largest of the three, with 1.2 million outstanding ratings and 1,416 analysts and supervisors; Moody's has 1 million outstanding ratings and 1,252 analysts and supervisors; and Fitch is the smallest, with approximately 350,000 outstanding ratings, and is sometimes

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of 2002, Congress ordered the U.S. SEC to develop a report, titled "Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets" detailing how credit ratings are used in U.S. regulation and the policy issues this use raises. Partly as a result of this report,

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CRAs are not only paid for giving ratings to structured securities, but may be paid for advice on how to structure tranches and sometimes the underlying assets that secure the debt to achieve ratings the issuer desires. This involves back and forth interaction and analysis between the sponsor of the

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is appointed to divide up the claims against the company. The effect of such ratings triggers, however, can be devastating: under a worst-case scenario, once the company's debt is downgraded by a CRA, the company's loans become due in full; if the company is incapable of paying all of these loans in

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found a serious lack of detail and rigour in many of the ratings issued by agencies. ASIC examined six agencies, including the Australian arms of Fitch, Moody's and S&P Global Ratings (the other agencies were Best Asia-Pacific, Australia Ratings and Equifax Australia). It said agencies had often

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S&P, Moody's and Fitch control 98 percent of the market for debt ratings in the U.S., according to the SEC. The noncompetitive market leads to high fees, says SEC Commissioner Casey, 43, appointed by President George W. Bush in July 2006 to a five-year term. S&P, a unit of McGraw-Hill Cos.,

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Rating entered a period of rapid growth and consolidation with this legally enforced separation and institutionalization of the securities business after 1929. Rating became a standard requirement for selling any issue in the United States, after many state governments incorporated rating standards

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in June 2003, the SEC published a "concept release" called "Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws" that sought public comment on many of the issues raised in its report. Public comments on this concept release have also been published on the SEC's website.

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but are "fundamentally commercial in character and should be subject to the same standards of liability and oversight as apply to auditors, securities analysts and investment bankers." Implementation of this amendment has proven difficult due to conflict between the SEC and the rating agencies. The

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mandated improvements to the regulation of credit rating agencies and addressed several issues relating to the accuracy of credit ratings specifically. Under Dodd-Frank rules, agencies must publicly disclose how their ratings have performed over time and must provide additional information in their

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CRAs provide "surveillance" (ongoing review of securities after their initial rating) and may change a security's rating if they feel its creditworthiness has changed. CRAs typically signal in advance their intention to consider rating changes. Fitch, Moody's, and S&P all use negative "outlook"

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Credit rating agencies originated in the United States in the early 1900s, when ratings began to be applied to securities, specifically those related to the railroad bond market. In the United States, the construction of extensive railroad systems had led to the development of corporate bond issues

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70%. "Firms bought mortgage-backed bonds with the very highest yields they could find and reassembled them into new CDOs. The original bonds ... could be lower-rated securities that once reassembled into a new CDO would wind up with as much as 70% of the tranches rated triple-A. Ratings arbitrage,

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Changes in the financial markets have made people think the agencies are increasingly important. ... What is disintermediation? Banks acted as financial intermediaries in that they brought together suppliers and users of funds. ... Disintermediation has occurred on both sides of the balance sheet.

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level. Some empirical studies have also found that rather than a downgrade lowering the market price and raising the interest rates of corporate bonds, the cause and effect are reversed. Expanding yield spreads (i.e., declining value and quality) of corporate bonds precedes downgrades by agencies,

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Fitch and S&P use (from the most creditworthy to the least) AAA, AA, A, and BBB for investment-grade long-term credit risk and BB, CCC, CC, C, and D for "speculative" long-term credit risk. Moody's long-term designators are Aaa, Aa, A, and Baa for investment grade and Ba, B, Caa, Ca, and C for

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When the United States began to expand to the west and other parts of the country, so did the distance of businesses to their customers. When businesses were close to those who purchased goods or services from them, it was easy for the merchants to extend credit to them, due to their proximity and

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80%. "In a CDO you gathered a 100 different mortgage bonds — usually the riskiest lower floors of the original tower ...... They bear a lower credit rating triple B. ... if you could somehow get them rerated as triple A, thereby lowering their perceived risk, however dishonestly and artificially.

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In the case of the one CRA that was a separate public company – Moody's – "Between the time it was spun off into a public company and February 2007, its stock had risen 340%. Structured finance was approaching 50% of Moody's revenue – up from 28% in 1998. It accounted for pretty

5831:

Adam Davidson: And by the way, before you finance enthusiasts start writing any letters, we do know that $ 70 trillion technically refers to that subset of global savings called fixed income securities. ... Ceyla Pazarbasioglu: This number doubled since 2000. In 2000 this was about $ 36 trillion.

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The agencies had charts and studies showing that their ratings were accurate a very high percentage of the time. But anyone who dig more deeply could find many instances when they got it wrong, usually when something unexpected happened. The rating agencies had missed the near default of New York

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According to the theoretical literature, CRAs potentially provide information, monitoring, and certification services. First, since investors do not often know as much as issuers about the factors that determine credit quality, credit ratings address an important problem of asymmetric information

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Critics argue that the issuer-pays model creates a potential conflict of interest because the agencies are paid by the organizations whose debt they rate. However, the subscription model is also seen to have disadvantages, as it restricts the ratings' availability to paying investors. Issuer-pays

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Under the subscription model, the credit rating agency does not make its ratings freely available to the market, so investors pay a subscription fee for access to ratings. This revenue provides the main source of agency income, although agencies may also provide other types of services. Under the

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These securities are more complex and an accurate prognoses of repayment more difficult than with other debt ratings. This is because they are formed by pooling debt — usually consumer credit assets, such as mortgages, credit card or auto loans — and structured by "slicing" the pool into multiple

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to each grade, preferring descriptive definitions, such as "the obligor's capacity to meet its financial commitment on the obligation is extremely strong", (from a Standard and Poor's definition of a AAA-rated bond) or "less vulnerable to non-payment than other speculative issues" (for a BB-rated

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What caused Moody's to change were three things. ... the inexorable rise of structured finance, and the concomitant rise of Moody's structured products business. ... the 2000 spin-off, which resulted in many Moody's executives getting stock options and gave them a new appreciation for generating

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Credit rating agencies began issuing ratings for mortgage-backed securities (MBS) in the mid-1970s. In subsequent years, the ratings were applied to securities backed by other types of assets. During the first years of the twenty-first century, demand for highly rated fixed income securities was

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The concern of the Justice Department's antitrust division was that unsolicited ratings were, in effect, anticompetitive. Rating firms could use the practice to 'improperly pressure' issuers in order to win business.... If they come to be viewed as 'shakedown artists,' using ratings to generate

1197:

calculated the additional interest rate or "spread" that corporate bonds pay over that of "riskless" US Treasury bonds, according to the bonds rating. (See "Basis point spread" in the table to right.) Looking at rated bonds from 1973 through 1989, the authors found a AAA-rated bond paid only 43

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In addition, rating agencies have been liable—at least in US courts—for any losses incurred by the inaccuracy of their ratings only if it is proven that they knew the ratings were false or exhibited "reckless disregard for the truth". Otherwise, ratings are simply an expression of the agencies'

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of 1933 and the separation of the securities business from banking. As the market grew beyond that of traditional investment banking institutions, new investors again called for increased transparency, leading to the passage of new, mandatory disclosure laws for issuers, and the creation of the

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to repay receives extra emphasis since national governments may be eligible for debt immunity under international law, thus complicating repayment obligations. In addition, credit assessments reflect not only the long-term perceived default risk, but also short- or immediate-term political and

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In 1913, the ratings publication by Moody's underwent two significant changes: it expanded its focus to include industrial firms and utilities, and it began to use a letter-rating system. For the first time, public securities were rated using a system borrowed from the mercantile credit rating

1603:. While this conflict had existed for years, the combination of CRA focus on market share and earnings growth, the importance of structured finance to CRA profits, and pressure from issuers who began to 'shop around' for the best ratings brought the conflict to a head between 2000 and 2007. 1534:

Aside from investors mentioned above—who are subject to ratings-based constraints in buying securities—some investors simply prefer that a structured finance product be rated by a credit rating agency. And not all structured finance products receive a credit rating agency rating. Ratings for

1308:

Defenders of credit rating agencies complain of the market's lack of appreciation. Argues Robert Clow, "When a company or sovereign nation pays its debt on time, the market barely takes momentary notice ... but let a country or corporation unexpectedly miss a payment or threaten default, and

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National governments may solicit credit ratings to generate investor interest and improve access to the international capital markets. Developing countries often depend on strong sovereign credit ratings to access funding in international bond markets. Once ratings for a sovereign have been

1634:. Alternative accounts of the agencies' inaccurate ratings before the crisis downplay the conflict of interest factor and focus instead on the agencies' overconfidence in rating securities, which stemmed from faith in their methodologies and past successes with subprime securitizations. 1594:

Critics blamed this underestimation of the risk of the securities on the conflict between two interests the CRAs have—rating securities accurately, and serving their customers, the security issuers who need high ratings to sell to investors subject to ratings-based constraints, such as

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Sovereign credit ratings represent an assessment by a rating agency of a sovereign's ability and willingness to repay its debt. The rating methodologies used to assess sovereign credit ratings are broadly similar to those used for corporate credit ratings, although the borrower's

1235:

Critics maintain that this rating, outlooking, and watching of securities has not worked nearly as smoothly as agencies suggest. They point to near-defaults, defaults, and financial disasters not detected by the rating agencies' post-issuance surveillance, or ratings of troubled

781:, allowing smaller reserves for higher-rated bonds; the rating would be done by "nationally recognized statistical ratings organizations" (NRSROs). This referred to the "Big Three", but in time ten agencies (later six, due to consolidation) were identified by the SEC as NRSROs. 784:

Rating agencies also grew in size and profitability as the number of issuers accessing the debt markets grew exponentially, both in the United States and abroad. By 2009 the worldwide bond market (total debt outstanding) reached an estimated $ 82.2 trillion, in 2009 dollars.

4956:"Not a single analyst at either Moody's of S&P lost his job as a result of missing the Enron fraud. Management stayed the same. Moody's stock price, after a brief tumble, began rising again .... 'Enron taught them how small the consequences of a bad reputation were.' 4804: 2057:

maintains an investor subscription service. Smaller, regional credit rating agencies may use either model. For example, China's oldest rating agency, Chengxin Credit Management Co., uses the issuer-pays model. The Universal Credit Ratings Group, formed by Beijing-based

2013:

Credit rating agencies generate revenue from a variety of activities related to the production and distribution of credit ratings. The sources of the revenue are generally the issuer of the securities or the investor. Most agencies operate under one or a combination of

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The rating agencies added levels of gradation to their rating systems. In 1973, Fitch added plus and minus symbols to its existing letter-rating system. The following year, Standard and Poor's did the same, and Moody's began using numbers for the same purpose in 1982.

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Mutual funds ... now contain $ 2 trillion in assets – not much less than the $ 2.7 trillion held in U.S. bank deposits. ... In 1970, commercial lending by banks made up 65% of the borrowing needs of corporate America. By 1992, the banks' share had fallen to 36%

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in 1971 led to the liberalization of financial regulations and the global expansion of capital markets in the 1970s and 1980s. In 1975, SEC rules began explicitly referencing credit ratings. For example, the commission changed its minimum capital requirements for

6120:"UBS banker Robert Morelli, upon hearing that S&P might be revising its RMSBS ratings, sent an e-mail to an S&P analyst. 'Heard your ratings could be 5 notches back of moddys equivalent, Gonna kill you resi biz. May force us to do moddyfitch only ...'" 1444:, there is no specific legislation governing contracts between issuers and credit rating agencies. General rules of contract law apply in full, although it is difficult to hold agencies liable for breach of contract. In 2012, an Australian federal court held 3984:

These courts have held, among other things, that rating agencies are protected by the "actual malice" standard, which insulates them from liability for their ratings unless the publications are made with "knowledge of falsity" or "reckless disregard for the

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has considered setting up a state-supported EU-based agency. In November 2013, credit ratings organizations from five countries (CPR of Portugal, CARE Rating of India, GCR of South Africa, MARC of Malaysia, and SR Rating of Brazil) joint ventured to launch

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high. Growth was particularly strong and profitable in the structured finance industry during the 2001-2006 subprime mortgage boom, and business with finance industry accounted for almost all of the revenue growth at at least one of the CRAs (Moody's).

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firms, resulting in a migration of credit rating analysts and the analysts' inside knowledge of rating procedures to higher-paying jobs at the banks and firms that issue the securities being rated, and thereby facilitating the manipulation of ratings by

1521:

Credit rating agencies employ varying methodologies to rate structured finance products, but generally focus on the type of pool of financial assets underlying the security and the proposed capital structure of the trust. This approach often involves a

3046:

The third period of rating development began in the 1980s, as a market in low-rated, high-yield (junk) bonds developed. This market – a feature of the newly released energies of financial globalization – saw many new entrants into capital

5907:"Unlike the traditional cash CDO, synthetic CDOs contained no actual tranches of mortgage-backed securities ... in the place of real mortgage assets, these CDOs contained credit default swaps and did not finance a single home purchase." (source: 1864:

The reason for the concentrated market structure is disputed. One widely cited opinion is that the Big Three's historical reputation within the financial industry creates a high barrier of entry for new entrants. Following the enactment of the

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issuer-pays model, agencies charge issuers a fee for providing credit rating assessments. This revenue stream allows issuer-pays credit rating agencies to make their ratings freely available to the broader market, especially via the Internet.

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Buffett explained that pricing power was what was important in his purchase of Moody's stock. '... he knew nothing about the management of Moody's. “I had no idea. I'd never been at Moody's, I don’t know where they are located.”' (source:

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notifications to indicate the potential for a downgrade within the next two years (one year in the case of speculative-grade credits). Negative "watch" notifications are used to indicate that a downgrade is likely within the next 90 days.

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The Big Three issued 97%–98% of all credit ratings in the United States and roughly 95% worldwide, giving them considerable pricing power. This and credit market expansion brought them profit margins of around 50% from 2004 through 2009.

3236:'The three major rating agencies hold a collective market share of roughly 95%. Their special status has been cemented by law – at first only in the United States, but then in Europe as well,' explains an analysis by DeutscheWelle. 1850:

Market share concentration is not a new development in the credit rating industry. Since the establishment of the first agency in 1909, there have never been more than four credit rating agencies with significant market share. Even the

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The three credit rating agencies were key enableers of the financial meltdown ... forces at work ... includ flawed computer models, the pressure from financial firms that paid for that ratings, the relentless drive for market share,

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Today expressions of concern about rating performance – how good the rating agencies are at their business – have become the norm. Newspapers, magazines, and online sites talk continuously about the agencies and their

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CRAs have argued that subscription-models can also be subject to conflicts of interest due to pressures from investors with strong preferences on product ratings. In 2010 Lace Financials, a subscriber-pays agency later acquired by

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Between the time it was spun off into a public company and February 2007, stock had risen 340%. Structured finance was approaching 50% of Moody's revenue – up from 28% in 1998. It accounted for pretty much all of Moody's

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The relative risks—the rating grades—are usually expressed through some variation of an alphabetical combination of lower- and uppercase letters, with either plus or minus signs or numbers added to further fine-tune the rating.

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It is very hard to see how this combination can be justified. Imagine if patients were forced to use doctors whose incomes depended on the pharmaceutical companies, but who were immune from lawsuits if they prescribed a toxic

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and for downgrading countries in the midst of that turmoil. Similar criticisms emerged after recent credit downgrades to Greece, Ireland, Portugal, and Spain, although credit ratings agencies had begun to downgrade peripheral

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The use of credit ratings by regulatory agencies is not a new phenomenon. In the 1930s, regulators in the United States used credit rating agency ratings to prohibit banks from investing in bonds that were deemed to be below

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height of the credit boom, S&P's operating profit rose 73 percent to $ 3.58 billion compared to the three-year period ending in 2004. The comparable gain for Moody's over the same period was 68 percent to $ 3.33 billion.

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trust that issues the security and the rating agency. During this process, the sponsor may submit proposed structures to the agency for analysis and feedback until the sponsor is satisfied with the ratings of the different

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found that agencies provide better ratings for the structured products of issuers that provide them with more overall bilateral rating business. This effect was found to be particularly pronounced in the run-up to the

1954: 898:. During that debacle, 73%—over $ 800 billion worth—of all mortgage-backed securities that one credit rating agency (Moody's) had rated triple-A in 2006 were downgraded to junk status two years later. In July 2008, 885:

launched an investigation into possible improper pressuring of issuers by Moody's in order to win business. Agencies were subjected to dozens of lawsuits by investors complaining of inaccurate ratings following the

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for rating agencies. By 2006, Moody's earned $ 881 million in revenue from structured finance. By December 2008, there were over $ 11 trillion structured finance debt securities outstanding in the US bond market.

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Conversely, the complaint has been made that agencies have too much power over issuers and that downgrades can even force troubled companies into bankruptcy. The lowering of a credit score by a CRA can create a

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removes statutory references to credit rating agencies, and calls for federal regulators to review and modify existing regulations to avoid relying on credit ratings as the sole assessment of creditworthiness.

7828: 2207:

For example, in the US, a state government which shares the credit responsibility for a Municipal bond issued by a municipal government entities but under the control of that state government entity. (source:

1579:"insurance", instead of interest and principal payments from house mortgages. If the insured or "referenced" CDOs defaulted, investors lost their investment, which was paid out much like an insurance claim. 5697: 707:

issued a publication focused solely on railroad bonds. His ratings became the first to be published widely in an accessible format, and his company was the first to charge subscription fees to investors.

1918: 1782:

The practice of using credit rating agency ratings for regulatory purposes has since expanded globally. Today, financial market regulations in many countries contain extensive references to ratings. The

736:

From 1930 to 1980, the bonds and ratings of them were primarily relegated to American municipalities and American blue chip industrial firms. International "sovereign bond" rating shrivelled during the

690:

in New York City. It was subsequently acquired by Robert Dun, who published its first ratings guide in 1859. Another early agency, John Bradstreet, formed in 1849 and published a ratings guide in 1857.

2964:

from the Bank for International Settlements via Asset Allocation Advisor. Original BIS data as of March 31, 2009; Asset Allocation Advisor compilation as of November 15, 2009. Accessed January 7, 2010.

1791:

and potentially cause systemic reactions. The regulatory function granted to credit rating agencies may also adversely affect their original market information function of providing credit opinions.

2267:(CDOs) issued in 2005-2007 (over half of the CDOs by value during time period) that rating agencies gave their highest "triple-A" rating to, were written down to "junk" by the end of 2009. (source: 2332:

Overall, my findings suggest that the problems in the CDO market were caused by a combination of poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures.

2041:

adopted the issuer-pays model. Several factors contributed to this transition, including increased investor demand for credit ratings, and widespread use of information sharing technology—such as

3612: 2005:'s Credit Research Initiative (Singapore, non-profit rating provider), Spread Research (independent credit research and rating agency, France), INC Rating (Poland), Scope Ratings GmbH (Germany). 1839:

The three largest agencies are not the only sources of credit information. Many smaller rating agencies also exist, mostly serving non-US markets. All of the large securities firms have internal

1008:' creditworthiness. However, in recent decades the paying customers of CRAs have primarily not been buyers of securities but their issuers, raising the issue of conflict of interest (see below). 1327:

The ratings process relies on subjective judgments. This means that governments, for example, that are being rated can often inform and influence credit rating analysts during the review process

3579:

In October 2007, the M4-M11 tranches were downgraded and by 2008, all the tranches were downgraded. Of all mortgage-backed securities it rated triple-A in 2006, Moody's downgraded 73% to junk.

3263:

has profit margins similar to those at Moody's, she says. 'They've benefited from the monopoly status that they've achieved with a tremendous amount of assistance from regulators,' Casey says.

8043:

On the limits of the current 'Issuer-pays' business model, see Kenneth C. Kettering, Securization and its discontents: The Dynamics of Financial Product Development, 29 CDZLR 1553, 60 (2008).

4899: 1926: 1320:

singled out methodological shortcomings—especially inadequate historical data—as a contributing cause in the underestimating of the risk in structured finance products by the CRAs before the

8082:

For an historical account of the interaction between a government and the rating agencies, see David James Gill, "Rating the UK: the British government's sovereign credit ratings, 1976–78,"

6160:

Oh God, are you kidding? All the time. I mean, that's routine. I mean, they would threaten you all of the time... It's like, 'Well, next time, we're just going to go with Fitch and S&P.'

3493: 2154:) have proposed removing the NRSRO rules completely. Professor Frank Partnoy suggests that the regulators use the results of the credit risk swap markets rather than the ratings of NRSROs. 638:

The value of credit ratings for securities has been widely questioned. Hundreds of billions of securities that were given the agencies' highest ratings were downgraded to junk during the

2297: 1587:

However, when it was discovered that the mortgages had been sold to buyers who could not pay them, massive numbers of securities were downgraded, the securitization "seized up" and the

1564:

From 2000 to 2007, Moody's rated nearly 45,000 mortgage-related securities as triple-A. In contrast only six (private sector) companies in the United States were given that top rating.

4226: 1338:

with their interest in providing accurate ratings of securities for investors buying the securities. Issuers of securities benefit from higher ratings in that many of their customers—

5449: 1530:. However, bank models of risk assessment have proven less reliable than credit rating agency models, even in the base of large banks with sophisticated risk management procedures. 1610:—drive a large amount of business to the ratings agencies, and thus have a much greater potential to exert undue influence on a rating agency than a single corporate debt issuer. 1209:), which often prohibit financial institutions from purchasing securities rated below a certain level. For example, in the United States, in accordance with two 1989 regulations, 716:" credit rating agencies were established. Poor's Publishing Company began issuing ratings in 1916, Standard Statistics Company in 1922, and the Fitch Publishing Company in 1924. 5770:

ank models of risk assessment have proved to be even less reliable than credit ratings, including in the largest banks where risk management was widely believed to most advanced.

2124:

of France, Germany and Switzerland (while the US and the UK were rather lukewarm) have unduly encouraged the use of ready-made opinions produced by oligopolistic rating agencies

2132:

described the company as "a natural duopoly", with "incredible" pricing power, when asked by the Financial Crisis Inquiry Commission about his ownership of 15% of the company.

906:

Downgrades of European and US sovereign debt were also criticized. In August 2011, S&P downgraded the long-held triple-A rating of US securities. Since the spring of 2010,

7899: 4520:

Note: Based on equally weighted averages of monthly spreads per rating category. Spreads for BB and B represent data from 1979-87 only, spreads for CCC, data for 1982-87 only.

3693: 3968: 3601: 752:. Also during that time, major agencies changed their business model by beginning to charge bond issuers as well as investors. The reasons for this change included a growing 5109: 1799: 1420: 1035:, a credit rating agency analyzes the accounts of the issuer and the legal agreements attached to the bond to produce what is effectively a forecast of the bond's chance of 1025: 801:

the move away from "intermediated" financing (bank loans) toward cheaper and longer-term "disintermediated" financing (tradable bonds and other fixed income securities), and

1645:

now requires credit rating agencies to use an additional symbol with ratings for structured finance instruments in order to distinguish them from other rating categories.

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In the late 1960s and early 1970s, raters began to charge fees to bond issuers to pay for ratings. Today, at least 75% of the agencies' income is obtained from such fees.

2143:

has eliminated competition between CRAs and practically forced market participants to use the services of the three big agencies, Standard and Poor's, Moody's and Fitch.

6275: 686:. These agencies rated the ability of merchants to pay their debts and consolidated these ratings in published guides. The first such agency was established in 1841 by 627:

that a security pays out, with higher ratings leading to lower interest rates. Individual consumers are rated for creditworthiness not by credit rating agencies but by

1934: 5487: 2194:

A debt instrument is any type of documented financial obligation. A debt instrument makes it possible to transfer the ownership of debt so it can be traded. (source:

6738: 1998: 4317: 2887:

When the phrase NRSRO was first used, the SEC was referring to the three agencies that had a national presence at that time, Moody's, Standard and Poor's and Fitch.

2094:

have been suggested as an alternative to both the subscription and issuer-pays models, although it is a recent development as of the 2010, and not yet widely used.

1020:

The ratings ... are and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell, or hold any securities.

5404: 5138: 1437:

magazine credits the free speech defence at least in part for the fact that "41 legal actions targeting S&P have been dropped or dismissed" since the crisis.

5017: 1970: 6345: 3613:

https://digitalcommons.mainelaw.maine.edu/cgi/viewcontent.cgi?referer=https://www.google.com/&httpsredir=1&article=1003&context=faculty-publications

3446:

Investors, including public pension funds and foreign banks, lost hundreds of billions of dollars, and have since filed dozens of lawsuits against the agencies.

6765: 1772: 7659: 4822: 3837: 8047: 7174:(chart of percentage of outstanding credit ratings reported to the SEC 2007 and 2011; and Moody's revenue and income 1996, 2000, 2010, 2012)| mcclatchydc.com 4389: 3209:(chart of percentage of outstanding credit ratings reported to the SEC 2007 and 2011; and Moody's revenue and income 1996, 2000, 2010, 2012)| mcclatchydc.com 2176: 2171: 2050: 1870: 1743: 2461: 4467: 4158: 3083: 2860: 1731: 5949: 2157:

The CRAs have made competing suggestions that would, instead, add further regulations that would make market entrance even more expensive than it is now.

1775:, and relied on such agencies exclusively for distinguishing between grades of creditworthiness in various regulations under federal securities laws. The 7139:

In the 12 months that ended in June 2011, the SEC reported that the big three issued 97% of all credit ratings, down only 1% from 98% in 2007. (sources:

2389: 1057:

speculative grade. Fitch and S&P use pluses and minuses (e.g., AA+ and AA−), and Moody's uses numbers (e.g., Aa1 and Aa3) to add further gradations.

7278: 5753: 5514: 2797: 7325: 8046:

For a renewed approach of CRAs business model, see Vincent Fabié, A Rescue Plan for rating Agencies, Blue Sky—New Ideas for the Obama Administration

7563: 6873: 3276: 3249: 1914: 1779:

of 2006 created a voluntary registration system for CRAs that met a certain minimum criteria, and provided the SEC with broader oversight authority.

1312:

A number of explanations of the rating agencies' inaccurate ratings and forecasts have been offered, especially in the wake of the subprime crisis:

1013: 8063:

Rating Agencies in the Face of Regulation—Rating Inflation and Regulatory Arbitrage, by Opp, Christian C., Opp, Marcus M. and Harris, Milton (2010).

4907: 4870: 3546:

In 2007, as housing prices began to tumble, Moody's downgraded 83% of the $ 869 billion in mortgage securities it had rated at the AAA level in 2006

2961: 1787:

accord, a global bank capital standardization effort, relies on credit ratings to calculate minimum capital standards and minimum liquidity ratios.

1690:

economic developments. Differences in sovereign ratings between agencies may reflect varying qualitative evaluations of the investment environment.

881:

As the influence and profitability of CRAs expanded, so did scrutiny and concern about their performance and alleged illegal practices. In 1996 the

7167: 5174: 5143: 3501: 3202: 2426: 1922: 1296: 1028:, this protection has been removed, but how the law will be implemented remains to be determined by rules made by the SEC and decisions by courts. 703:, demand rose for such independent market information, in particular for independent analyses of bond creditworthiness. In 1909, financial analyst 6408: 3776: 7928: 7230: 6173: 3746: 7481: 5832:

Adam Davidson: So it took several hundred years for the world to get to $ 36 trillion. And then it took six years to get another $ 36 trillion.

3529: 3220: 3166:

By 2006, Moodys' had earned more revenue from structured finance – $ 881 million – than all its business revenues combined for 2001

3149: 2238: 1938: 1544: 1357:

The rating agencies may have been significantly understaffed during the subprime boom and thus unable to properly assess every debt instrument.

1230: 566: 46: 6846: 6819: 6678: 5302: 5288: 4627: 1535:

complicated or risky CDOs are unusual and some issuers create structured products relying solely on internal analytics to assess credit risk.

6651: 4971:""In Search of Transparency, Accountability, and Competition: The Regulation of Credit Rating Agencies", remarks at "The SEC Speaks in 2009"" 4234: 4126: 3666: 3628: 1883: 7580: 6711: 5781:

set up by the US Congress and President to investigate the causes of the crisis, and publisher of the Financial Crisis Inquiry Report (FCIR)

1877:, and in October 2012 several announced plans to join together and create a new organization called the Universal Credit Rating Group. The 4600: 3602:

https://scholarlycommons.law.case.edu/cgi/viewcontent.cgi?referer=https://www.google.com/&httpsredir=1&article=1136&context=jil

7503: 7742: 7308: 7095: 1493:

Credit ratings for structured finance instruments may be distinguished from ratings for other debt securities in several important ways.

517: 4290: 6927: 4260: 7464:"Securities and Exchange Commission: Action Needed to Improve Rating Agency Registration Program and Performance-related Disclosures" 4362: 6900: 5615: 3709: 1241: 699:'s publishing company, which produced a publication compiling financial data about the railroad and canal industries. Following the 1977:(U.S.), Muros Ratings (Russia, alternative rating company), Public Sector Credit Solutions (U.S., not-for profit rating provider), 1316:

The methodologies employed by agencies to rate and monitor securities may be inherently flawed. For instance, a 2008 report by the

1557:, providing reassurance of the soundness of the securities to money manager investors with "no history in the mortgage business". 6792: 6310: 1982: 1798:, legislators in the United States and other jurisdictions have commenced to reduce rating reliance in laws and regulations. The 1768: 7535:

In some countries, credit rating agencies are starting to provide other types of services, including credit reporting serv-ices.

7337: 3810: 7621: 7150: 5922: 558:

obligations, of debt instruments, and in some cases, of the servicers of the underlying debt, but not of individual consumers.

2929: 1424:

analyses so investors can make better decisions. An amendment to the act also specifies that ratings are not protected by the

741:

to a handful of the most creditworthy countries, after a number of defaults of bonds issued by governments such as Germany's.

7784: 7373: 6679:"The Role of Credit Rating Agencies in the Establishment of Capital Standards for Financial Institutions in a Global Economy" 6287: 6249: 2343: 2113: 2049:—which allowed investors to freely share agencies' reports and undermined demand for subscriptions. Today, eight of the nine 239: 6452: 4644:

A more recent example is the 1989 regulation allowing pension funds to invest in asset-backed securities rated A or higher.

1694:

initiated, the rating agency will continue to monitor for relevant developments and adjust its credit opinion accordingly.

1471: 4047: 2769:

In this era of rating conservatism, sovereign rating coverage was reduced to a handful of the most creditworthy countries.

7527: 4325: 1550: 1475: 882: 5877:

Wall Street called this practice. A more accurate term would have been ratings laundering." (source: McLean and Nocera,

546:, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of 7669: 7105: 7075: 6937: 6910: 6883: 6856: 6829: 6802: 6775: 6748: 6721: 6661: 6464: 6355: 6183: 5763: 5736: 5726: 5709: 5524: 5497: 5353: 5211: 5063: 4949: 4832: 4771: 4576: 4399: 4372: 4300: 4136: 4030: 3931: 3878: 3847: 3786: 3676: 3402: 3346: 3032: 2988: 2755: 2698: 2607: 2524: 2166: 1930: 1817: 1660: 1408: 730: 713: 650: 5021: 3429: 8076: 6106: 6045: 6008: 4736: 4676: 4610: 3703: 3133:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. pp. 43–44. 2939: 2643: 2434:. The Role of Credit Reporting Systems in the International Economy. Washington, D.C.: The World Bank. Archived from 2401: 895: 80: 5405:"Bill Summary & Status – 111th Congress (2009–2010) – H.R.4173 – All Information – THOMAS (Library of Congress)" 2277:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. pp. 228–9. 1001:. In market practice, a significant bond issuance generally has a rating from one or two of the Big Three agencies. 6073:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. pp. xxv. 5166: 2022:

and the issuer-pays model. However, agencies may offer additional services using a combination of business models.

2002: 1407:. Since that time, major agencies have put extra effort into detecting them and discouraging their use, and the US 6158:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. p. 210. 8117: 7949:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. p. 207. 5866:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. p. xxv. 5799:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. p. 44. 3590: 1874: 1866: 1852: 1776: 639: 510: 6453:"38: Can Sovereign Credit Ratings Promote Financial Sector Development and Capital Inflows to Emerging Markets?" 4486: 3569:. National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. p. 122 3102: 2879: 2038: 1825: 1618: 658: 7029: 6694: 5946: 5459: 4340: 4270: 3756: 3638: 2264: 1638: 1568: 1479: 915: 858: 808:

based on (among other things) global capital markets and arms-length relations between government and industry.

725: 704: 643: 601: 166: 121: 3591:"Recommendations of the Securities Industry and Financial Markets Association Credit Rating Agency Task Force" 5408: 2805: 1986: 1641:, various legal requirements were introduced to increase the transparency of structured finance ratings. The 1257: 1249: 17: 7865: 7554: 4193: 7723: 6982: 6419: 3303: 3284: 3257: 2030: 1821: 1622: 1261: 1214: 1051: 654: 6999: 5540: 1575:". Cheaper and easier to create than ordinary "cash" CDOs, they paid insurance premium-like payments from 7686: 4881: 2900:"Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organization" 2312: 2071: 2067: 2059: 2019: 1978: 1702: 1678: 1253: 1245: 820:

blossomed in the late 1970s, expanding securities financing to firms other than a few large, established

682:

Mercantile credit agencies—the precursors of today's rating agencies—were established in the wake of the

7164: 5814: 4571:. Ithaca, New York: Cornell University Press. p. 36, Bond Rating Symbols and Definitions, Table 2. 3199: 2781:

White, Ben (31 January 2002). "Do Rating Agencies Make the Grade?; Enron Case Revives Some Old Issues".

2435: 1763:. In the following decades, state regulators outlined a similar role for agency ratings in restricting 7809: 7239: 6576:"Comments on S7-12-03: Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws" 4852: 4534:

Cantor, R., Hamilton, D.T., Kim, F., and Ou, S., 2007 Corporate default and recovery rates. 1920-2006,

4449: 1962: 1873:(NRSROs). While these other agencies remain niche players, some have gained market share following the 712:

agencies, using letters to indicate their creditworthiness. In the next few years, antecedents of the "

503: 365: 141: 7048: 6953: 5020:. International Herald Tribune via Internet Archive. Associated Press. August 22, 2008. Archived from 2597: 952: 7846: 7122: 6132: 5965: 5430: 4072: 1950: 1317: 963:, CRAs theoretically reduce information costs, increase the pool of potential borrowers, and promote 724:

In the United States, the rating industry grew and consolidated rapidly following the passage of the

58: 3533: 3224: 3153: 2568: 2242: 1760: 1697:

A 2010 International Monetary Fund study concluded that ratings were a reasonably good indicator of

1510:

restricted to higher-rated debt, and for use by banks wanting to reduce costly capital requirements.

5313: 5239:"The financial crisis and the regulation of credit rating agencies: A European banking perspective" 1966: 1795: 1631: 1387: 1321: 1273: 891: 854: 821: 665:

controls a further 15%. They are externalized sell-side functions for the marketing of securities.

597: 161: 62: 8054:

Frank J. Fabozzi and Dennis Vink (2009). "On securitization and over-reliance on credit ratings".

3458:

Utley, Michael (12 June 1996). "Orange County widens lawsuit to include S&P, Morgan Stanley".

6929:

Corporate Governance Failures: The Role of Institutional Investors in the Global Financial Crisis

5263: 4424: 3894: 3726: 1899: 1654: 1614: 1445: 1372:

The functional use of ratings as regulatory mechanisms may inflate their reputation for accuracy.

616: 481: 7599: 7374:"SFC achieves smooth transition for credit rating agencies falling within new regulatory regime" 5201: 5055: 4700:"Sovereign Rating News and Financial Markets spillovers: Evidence from the European Debt Crisis" 4566: 3921: 3473:"Ratings in structured finance: what went wrong and what can be done to address shortcomings?". 3392: 3336: 3022: 2978: 2745: 2688: 2514: 2082:, was fined by the SEC for violating securities rules to the benefit of its largest subscriber. 8061:

For a theoretical analysis of the impact of regulation on rating agencies' business model, see

7510: 5238: 4668: 4019:

John B Caouette; Edward Altman; Paul Narayanan; Robert Nimmo (2008). "6: The Rating Agencies".

2563: 1953:(U.S.), Global Credit Ratings Co. (South Africa), HR Ratings de México, S.A. de C.V. (Mexico), 1909:

Infomerics Credit Rating Nepal Limited (Nepal), Acuité Ratings & Research Limited (India),

1723: 1400: 1205:

The market also follows the benefits from ratings that result from government regulations (see

1186: 922:

instability, S&P downgraded nine eurozone countries, stripping France and Austria of their

612: 585: 340: 187: 8027: