Analytical failures by the credit rating agencies (CRAs) were a central cause of the financial meltdown that occurred last year. According to Lord Turner, credit ratings were involved in the origins of the crisis for three reasons: the increase in the role of securitized credit, especially the growth of the credit derivatives market; ratings for structured credit proved less robust than ratings for single securities; and conflicts of interest and the failure of analytical independence at the CRAs.1
Previously, CRAs failed to predict the demise of Enron, WorldCom and others in the early years of this century. Although there then was a reaction in favor of regulation of the CRAs in the United States and the European Union (EU) leading to some reforms designed to improve the quality of ratings, further new regulations have recently been adopted and proposed. Although CRAs have been rating public and private debt for a hundred years, their methods of operation and effect on the financial markets have changed in recent years. They no longer operate on a subscriber pays model, the major CRAs are public companies, and their influence on structured finance products is profound.
