The Credit Rating Agencies, Their Role in the Financial Crisis and What Is Next?

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End of Studies Thesis

What is the role of the credit rating agencies, which part did they play in the recent Financial Crisis and how can their efficiency be improved?

Thesis Supervisor – David Menival

Emmeline Beauchamp – Cycle Franco- US – March 2013

Acknowledgments
I would first like to thank RMS and especially the CESEM to have taught me a lot, helped me to grow and open up and gave me this incredible opportunity of studying two years in the United States. None of this phenomenal experience would have been possible without them.

I would also like to thank Northeastern University for allowing me to discover a new culture and a different educating system. It also had a tremendous role in my future accomplishment and professional career.

In addition, I would like to thank all the professors I had during these four years of studying, whether it is at CESEM or at Northeastern University. They made this journey even more profitable and enjoyable. I would also like to thank David Menival, my thesis supervisor, who accepted to work with me on this project.

Finally, I would like to thank my parents for always supporting my choices and being next to me when I needed them. They have been my guides and models in life and have always encouraged me to be better and push myself.

Table of Content
Introduction4

I. Credit Rating Agencies: Role and methods5
1) History5

2) Role and methods7

3) The Issuer-Payer model 9

II. The Credit Rating Agencies and the Financial Crisis: is the thermometer responsible for the fever?12

1) Background of the financial Crisis12

2) Credit Rating Agency are not fully responsible… 14

3) …But they could have done better17

III. What is next?20
1) Lessons learned from the crisis 20

2) Regularization of the existing Credit Rating system 21

3) A new rating system23

4) Creation of new Credit Rating Agency24

Conclusion26
Exhibits27
Bibliography32

Introduction

A credit rating agency is a company whose role is to evaluate the default risk of a borrower, whether it is a private or public company or a State. Since 1909, when Moody’s emitted its first rating, the role of the Credit Rating Agencies has considerably evolved and the methods used have improved. Even though their ratings do not constitute buying or selling recommendations, they rapidly gained an almost “biblical authority”. Since the 1980’s, the credit rating agencies have, indeed, become a reference for investors that want to determine the creditworthiness of an entity. Their ratings influence investors’ behaviors and they are indirectly involved in the future of a State or company.

After several economic meltdowns and the recent financial crisis, the three big Credit Rating Agencies have been the center of attention. Is their methodology appropriate to evaluate the creditworthiness of an entity? Does the issuer-payer model insure the best transparence?

Their role and implications in the crisis have been meticulously examined and their functioning system has been questioned. Although their role in the crisis in undeniable, are the only responsible of the crisis? The system was defaulting and the predictions of the credit rating agencies turned out to be wrong. Which modifications should we bring to the system to make it more transparent and efficient? These are the questions we will try to answer throughout this thesis.

I. Credit ratings agencies: role and methods

Credit Ratings agencies, entity still little known outside the financial communities two years ago, found themselves at the center of attention with the subprime crisis. If everyone more or less gets, now, familiar with what a credit rating agency is, people usually do not know what are the origins of this business, its rationale and its financing model. 1) History

The influence of the three main credit rating agencies (Moody’s, Standard & Poor’s and Fitch Ratings) was build step by step since their...
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