Question

A controversy erupted regarding bond- rating agencies when some agencies began to provide unsolicited bond ratings. Why do you think this is controversial? Additionally, around the time that real estate began to drop sharply the rating agencies again came under fire as nearly all real estate back bonds were rated triple A. Can anyone find more information on this controversy?

Answer 1

The controversy in relation to bond ratings was due to the fact that agencies were giving unsolicited bond ratings.Bond ratings range from AAA for high quality to D for low quality bonds(S&P and Fitch) .The bond ratings given by the agencies indicate the credit worthiness of the issuing firms(their ability to repay the debt). This information is used by investors to make informed investment decisions.The fee for rating the debt issue is incurred by the companies(issuing them)(This is the model followed by the big three bond rating agencies). So since the companies are incurring the cost with regard to bond ratings they wanted the ratings to be given after proper research into the company,it's track record etc.But when bond rating agencies started giving unsolicited ratings to issues and then began requiring companies to pay them to improve them their ratings it became controversial.

Bond rating agencies came under fire during the 2007-2008 financial crisis (due to the collapse of the housing market)for giving ratings that did not reflect the actual financial state of the issuing companies.One such instance was when 83% of over $869 billion in mortgage securities which was given AAA rating was downgraded by the rating agency as soon as the housing prices began to decline (signalling the collapse of the housing market). The ratings agencies were accused of giving ratings that made compromises to the quality in an attempt to make major gains for themselves.The Dodd-Frank Wall Street Reform and Consumer Protection Act which was signed into law by the President Barack Obama gave SEC the power to evaluate the ratings by the agencies to prevent a repetition of such instances.