The Shocking Truth About Credit Ratings Agencies
Subprime Homes and Student Phones
City credit rating agencies such as Standard and Poor’s, Moody’s and Fitches have gained a justified level of notoriety for their role in facilitating the financial bubble which led to the inevitable financial crash. They were each reluctant to assign the correct level of risk to the structured financial products which had become such a high earner for those in the city. In reality these products were opaque to the extent that these firms had no real measure of the risk these products carried, nonetheless labeling them at the top level, triple A. The collapse of Worldcom and Enron revealed the reluctance of the credit rating agencies to make vital decisions to downgrade ratings given to booming assets.
The inability of the agencies to inform investors of the risk in backing sub-prime collateral debt obligations was even more noticeable than the failings which led to the technology bubble at the beginning of the century. This negligence has led to many questioning the need for the agencies entirely; surely misleading asset valuation is worse than none at all? At least if investors knew they faced information asymmetries they could act accordingly. Empirically it has been demonstrated that ratings are often reactive to market prices rather than having a more logical effect of dictating them.
The false sense of security an overrating can provide, prevents a greater level of market-led investor scrutiny that would otherwise prevail, this would at least be an effective solution in a world of perfectly obtainable information. The oligopoly enjoyed by Standard and Poor’s, Moody’s and Fitches however, have raised these companies’ profits, while lowering the level of service throughout the market. For some reason though, the consumer credit market is not plagued with these same issues; is it uncommon to receive a surprisingly high credit score but not to receive an unfairly low score, why? Not too long ago with no history of late payments on my credit report, I was refused a contract for a phone.. Why does such a disparity between the wild optimism for commercial and financial assessment and inhibitive prudence in the consumer risk assessment world exist?
In part this can be assigned to the concept of regulatory capture. Ratings agencies are subjected to conflicting motives, a moral hazard, particularly in the anti-competitive oligopolistic market conditions. The agencies were in the midst of record success in mid 2007 as a direct consequence of the fervent popularity of collateralised debt. Structured financial products were responsible for nearly half of these firms’ profits at the inception of the sub-prime crisis. Encouraging prudence upon their clients was not an option for these firms; instead they told them what they wanted to hear, what was making them the most money and what all the other agencies were saying. If one of the oligopolists was to have unilaterally stopped the madness of overrated debt they would have been disparaged by the rest of the city and operating against their best interest.
Only in an uncompetitive market place would it be in a firm’s best interest to destroy its long term reputation: as long as all of them were together, bar a rejection of the agencies altogether, there would be no consequences. In a competitive market, a startup agency could have solidified its reputation in the long run by making a more accurate assessment of this risk. The tightly-knit financial community fell victim to a form of ‘agency capture.’
Regulators and ratings agencies alike have allegiances to more than their own organisation, the factors leading to their decisions, governed by personal allegiances and future job prospects, are rarely conducive to downgrades of the assets owned by SIVs. Not possessing this same influence over my credit ratings, I am left to ponder where I went wrong and why I am still have to make do with my pay as you go phone… If only Bradford and BIngley had offered phones on credit.
If you are having trouble with obtaining credit, it makes sense to check your credit report. If there are errors on your report they can be contested, check the website of your credit check company for details. If you are struggling to deal with debt, dont pay extortionate interest on payday loans, seek some professional financial advice.
