THE CREDIT RATINGS GAME
1. Background /Introduction
A credit rating is an estimate of the credit quality of a company or a financial security. Historically, credit ratings have been most commonly issued in case of public debt issued by corporations. In that case, credit rating is based on the credit history of the borrower, its assets and liabilities, and its total business activity. The informational role of credit ratings is crucial for the functioning of modern financial markets. On one hand, the borrowers can improve conditions for raising capital and the overall perception of the market if they have good credit ratings. On the other hand, investors can use the ratings to assess the likelihood of repayment, which is crucial for pricing of securities. Thus, credit rating agencies provide signals to market participants on the credit quality of financial securities, both new and already existing in the market. As such, they are the first line of defense of investors against unnecessary credit risk exposure. This is especially true for those investors for whom it is too costly to perform their own credit analysis of available public securities. Onset of financial globalization and increased dependence of financial institutions on wholesale funding made credit ratings issued by major Credit Rating Agencies (CRAs) an indispensible part of the investment process.
2. Purpose of the Study
The main purpose of this study is to analyze the collapse of so many AAA-rated structured finance products in 2007-2008 has brought renewed attention to the causes of ratings failures and the conflicts of interest in the Credit Ratings Industry. The main purpose of this study is to; • Eliminate the CRA conflicts of interest by preventing issuers from influencing ratings, • Prevent issuers from shopping for ratings and disclosing only those ratings they prefer, and • Monitor the quality of the ratings methodology....