The Credit Rating Agencies and Their Contribution to the Financial Crisis

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The Political Quarterly, Vol. 83, No. 1, January–March 2012

The Credit Rating Agencies and Their Contribution to the Financial Crisis MAURICE MULLARD

Introduction
The central concern of this article is to explore the question of whether the Credit Rating Agencies (CRAs) contributed to the financial crisis of 2007. In debating this issue there are two perspectives. The first is presented by the senior managers of the CRAs who pointed out that all major market participants, including the CRAs, did not predict the depth of the financial crisis and that the crisis was an exogenous event. The alternative view tends to put the emphasis on institutional failures, including deficiencies in the mathematical models used by the CRAs, the conflict of interests inherent in the user pays model and the quasi monopoly positions of the CRAs.1 Evidence produced in testimonies by analysts and Moody’s and Standard & Poor’s (S&P) tended to put the focus on market share that undermined the ethics of independent impartial analysis. In the following sections it shall be argued that the study of the ratings process confirms the view that the priority of the management teams at the CRAs was to maintain market share and to issue a rating for a bond, even when their analysts expressed concern about the soundness of the securities was a contributory factor in the financial meltdown. There have been a number of factors outlined at different enquiries2 to try and explain how the CRAs failed to forecast major downgrades in such a short space time of time when it was the taken-forgranted assumption that triple-A ratings had a minimum life expectancy of seven years.3 These explanations included:

. The CRA ‘business issuer pays’ model

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which altered the priorities of the CRAs as they became more focused on generating fees and higher profits. The issue of conflict of interest between the commitment of the impartial agency and issuer fees that undermined the ethics of the research-based analysis and the managerialism of the CRAs. The failure of the mathematical models, mainly because the data did not reflect the new mortgages and relied on classic thirty-year traditional mortgages. The new adjustable rate mortgages, teaser mortgages and nondocumented mortgages were qualitatively different from traditional mortgages. Furthermore, there was reluctance on the part of the CRAs to deploy revised mathematical models. Evidence given by analysts at a number of enquiries showed the reluctance of some of them to rate some issues as they were ignored, marginalised and in some cases made redundant by their management teams. Despite the heavy workloads, the CRAs were understaffed and the new staff being recruited did not have sufficient expertise to deal with the need for due diligence in dealing with issuers of asset-backed bonds. The legal framework did not provide a context for CRAs to be taken to court for lack of diligence and for error in the ratings of bonds. CRAs were therefore exempt from legal accountability for their performance. 77

# The Author 2012. The Political Quarterly # The Political Quarterly Publishing Co. Ltd. 2012 Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA

The Securities and Exchange Commission report of September 2008 starts with the following remark: Beginning in 2007, delinquency and foreclosure rates for subprime mortgage loans in the United States dramatically increased, creating turmoil in the markets for residential mortgage-backed securities backed by such loans. . . .The rating agencies performance in rating these structured finance products raised questions about the accuracy of their credit ratings generally as well as the integrity of the ratings process as a whole.4

The report concluded that while the workloads of the CRAs on the new asset-backed securities increased, especially on the collateralisation of collateralised debt...
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