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A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain type of debt obligations as well as the debt instruments themselves. The rating represents the CRAs evaluation of fundamental and technical health of the company. A poor rating indicates a CRAs view that the company or govt. has a high risk of defaulting, based on the agencys analysis of long term economic prospects.
Criticism
Enron's rating remained at investment grade four days before the company went bankrupt Moody's gave Freddie Mac preferred stock the top rating until Warren Buffett talked about Freddie on CNBC. He said game is over for Freddie and Fannie and that they do not have any net worth And on the next day Moody's downgraded Freddie to one tick above junk bond.
These agencies meet frequently in person with the management of many companies, and advise on actions the company should take to maintain a certain rating. CRAs are accused of being too cozy with the companies they rate, and are accused of being too focused on a company's "bottom line and unwilling to listen to a company's explanations for its actions.
Moody's published an "unsolicited" rating of Hannover Re, with a subsequent letter to the insurance firm stating that "it looked forward to the day Hannover would be willing to pay In 2004, Moodys cut Hannover's debt to junk status, and even though the insurer's other rating agencies gave it strong marks
Credit Rating Agencies have made errors of judgment in rating structured products
Assign AAA ratings to structured debt, which in a large number of cases has subsequently been downgraded or defaulted. Many of the structured financial products that they were responsible for rating, consisted of lower quality 'BBB rated loans, but were, when pooled together into CDOs, assigned an AAA rating
Unprecedented Downgrade
On August 5, S&P downgraded U.S. debt for the first time in U.S. history, by one notch from AAA to AA+
Congressional leaders and the White House reached a deal to avert default in the nick of time, but, in the opinion of S&P, did not implement significant measures to reduce the U.S. deficit over the next ten years President Obama sought to diminish the importance of S&P's verdict, citing investor Warren Buffett, who said the United States should have a "quadrupleA rating." S&P forcefully defended its decision in the wake of criticism. Nonetheless, in the first days of trading after the downgrade, global markets from Asia to Wall Street responded with a steep sell-off, which triggered volatility in equity markets not seen since the financial crisis.
Similarly, the EU's oversight mechanism, the ESMA, "contributes to the development of a single rulebook in Europe" by ensuring the "consistent treatment of investors across the Union and enabling an adequate level of protection of investors through effective regulation and supervision.
In the wake of the Portugal downgrade, Commissioner Barnier, in addition to calling for a European agency, said the EU would reveal further measures to regulate the Big Three in the fall of 2011, forcing them to be more transparent. But we argue that government regulation is unlikely to solve the conflicts inherent in credit rating agencies, particularly when it comes to sovereign debt. The best way to counter the monopolistic power of the Big Three, we argue, is to stop putting so much weight in their ratings.
Preferential Treatment?
European officials have publicly accused the Big Three of showing preferential treatment to the United States, which until August 5 maintained a AAA rating, despite carrying an unsustainable deficit and increasingly high levels of public debt. The EU has also criticized excessive speculation by the U.S. agencies over European debt, even as concrete budgetary policies are being implemented by Eurozone periphery states--most recently, Spain and Italy -at risk of contagion. Many European officials, including European Commissioner for Internal Market and Services Michel Barnier, have called for the creation of an independent, European rating agency to counter the influence of the Big Three. Barnier even echoed former French finance minister and current IMF chief Christine Lagarde, saying that credit rating agencies should be banned from rating countries that are receiving international aid plans. Could a new rating agency compete with the well-established Big Three? "If you are a rating agency, and if you want to be a rating agency that enjoys credibility on the markets, you need to be able to demonstrate that you have a big stock of clients who are buying your services because they believe in what you're doing," Can a European-created agency would be able to maintain independence, particularly when rating sovereign debt, since it would be "a politically created body."
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