Tuesday, October 5, 2010

Who Rates the Credit Rating Agencies?

Back in the crazy days of sub prime mortgages, credit Rating Agencies gave AAA rating to subprime mortgage bundles. These mortgages were often completely divorced from reality. People on low incomes with bad credit histories were sold mortgages, they effectively couldn't afford to pay. - especially when cheap introductory mortgage deals ended. Because they were rated as AAA. These mortgage bundles were snapped up by banks and financial institutions. It was only when it was too late, that people realised, these debt bundles were worse than useless.

Bad credit ratings were only part of the problem. Mortgage companies can be blamed in the first instance. Banks were also lazy in accepting the ratings of external credit rating agencies. But, it does show that just because you are an independent credit rating agencies doesn't give you infallibility, they often seem to claim.

Credit Rating agencies seem to wield enormous power. A credit rating agency which threatens to reduce a countries AAA rating, can be the main justification for far ranging spending cuts. Take the example of Ireland, told a while back to cut spending and reduce the deficit by credit rating agencies, they did - only to damage their economy and lead to a credit downgrade, higher interest rates and the call for more austerity.

Fitch, Moody's and Standard and Poor have been implicitly allowed by governments to fill a quasi-regulatory role. But, because they are profit oriented organisations. There is a fear they may get more business by getting in the headlines by threatening default.

Implications of debt downgrade


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