Question

1. Describe the issue associated with credit rating agencies in the context of the global financial crisis.
2. Given the issues described in question 1, do you think we need credit rating agencies going forward? Why (not)?

Answer 1

1Describe the issue associated with credit rating agencies in the context of the global financial crisis.

A rating agency evaluates a company's or government entity's financial strength, particularly its ability to make principal and interest payments on its obligations. The credit rating provided to a loan reflects an agency's confidence in the borrower's ability to meet its debt obligations as agreed. Each agency utilizes its letter-based ratings to determine whether a debt has a low or high default risk, as well as the issuer's financial soundness (MULLARD, 2016). Sovereign nations, municipal and state governments, particular purpose institutions, corporations, and non-profit organizations are potential debt issuers. Credit bureaus came under fire during the 2008 Global Financial Crisis for assigning high credit ratings to loans that later turned out to be high-risk ventures. They failed to recognize dangers that would have alerted investors to avoid certain loans, such as mortgage-backed securities. Rating agencies have also been chastised for apparent conflicts of interest with securities issuers. Because rating agencies are paid by the individuals who pay their salaries, they may be hesitant to award abysmal ratings to securities issued by those who pay their wages.

2  Given the issues described in question 1, do you think we need credit rating agencies going forward? Why (not)

Despite the issues associated with the Credit Rating Agencies, we still need them going forward because they play an essential role in the Capital Market. Rating agencies assess the credit risk of individual debt securities and borrowing companies. In the bond market, a rating agency assesses the creditworthiness of debt instruments issued by governments and businesses on an impartial basis. One or two of the leading three rating firms assign ratings to large bond issuers. In the United States, agencies are held liable for losses incurred due to erroneous or fraudulent ratings (Kiesel, 2015). The ratings are used in asset-backed securities, mortgage-backed securities, and collateralized debt obligations, among other structured finance transactions. Rating agencies look at the kind of pool underpinning the asset and the anticipated capital structure to grade structured financial products. Structured product issuers pay rating agencies to evaluate the products and advise them on arranging the tranches. Sovereign borrowers, who are the largest in most financial markets, are also rated by rating agencies. National governments, state governments, municipalities, and other sovereign-supported organizations are examples of sovereign borrowers. A rating agency's sovereign rating indicates a country's capacity to repay its debt.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

A rating agency evaluates a company's or government entity's financial strength, particularly its ability to make principal and interest payments on its obligations.