Credit Rating Agencies: Where did they go wrong?

Personally I believe that the credit rating agencies are the main factor which contributed to the collapse of the subprime mortgage crisis. Securitization was only a problem because the securities were given overly optimistic ratings which gave investors a false sense of security. Pools of Jumbo, Subprime and Alt A mortgages were magically transformed into securities with AAA ratings and the only excuses which I can fathom for these unrealistic ratings are either incompetence or greed. 

One of the major problems with these credit rating agencies is that they made money by charging private issuers for a rating. This created a conflict of interest as they were being paid by those who were judging them and were themselves competing with other rating agencies for profits. Many critics claim that this conflict of interest led agencies to award these AAA ratings to these complex securities which they did not properly understand.

These same rating agencies have failed before and will fail again. Thailand maintained an investment grade rating until 5 months after the Asian financial crisis, whilst Enron, the largest bankruptcy in US history at the time, had an investment grade rating until just days before it went bankrupt.

In May 2008, Moody’s acknowledged that it had given AAA-ratings to billions of dollars of structured finance products due to a bug in one of its ratings models (Jones, Tett, and Davies, 2008). In March 2007, First Pacific Advisors discovered that Fitch used a model that assumed constantly appreciating home prices, ignoring the possibility that they could fall. (Coval, J.D et al, 2008)

They have not learned their lesson and they have a lot to answer for when it comes to the subprime mortgage crisis. Bill Gross gave his view on the credit ratings agencies which I believe sums there role up appropriately.

“AAA? You were wooed Mr. Moody’s and Mr. Poor’s by the makeup, those six-inch hooker heels, and a ‘tramp stamp.’ Many of these good-looking girls are not high-class assets worth 100 cents on the dollar.”