Question

Many people believe the bond ratings agencies played a role in the financial meltdown and mortgage crisis that began around 2008. What do you think were some of the issues people had with the bond rating agencies and were those issues reasonable?

Answer 1

Credit rating agencies plays a important role for both creditors and borrowers. The ratings which are given by rating agencies forms the basis for creditors to lend money to borrowers. These agencies helps in reducing the information gap and giving a better view of the credit profile of the borrower. In 2008 financial crisis, there were many corporate bonds which were unduly rated very high, some of them even rated AAA. The true picture of these bonds, however, was quite different. The bonds did not turn out credit worthy and a series of events has led to the financial meltdown. In order to increase market share of their business, and profit from these companies and business, lot of inaccurate credit ratings were given to bonds which were not worth the same. These agencies were then blamed for having conflict of interest and the methodologies adopted for rating these bonds were considered suspicious by people.

These issues were reasonable to quite an extent, because bond rating agencies are expected to remain neutral while rating to bonds. They have the responsibility to give a true and fair view of the creditworthiness of borrowers. The business of credit rating can not be solely run for the purpose of increasing market share and earning higher profits. Having said that, it is equally important for investors to make a reasonable research with regards to creditworthiness of borrower and whether their investment will turn profitable or not.