Criticism

• Credit rating agencies do not downgrade companies promptly enough. For example, Enron's rating remained at investment grade four days before the company went bankrupt, despite fact that credit rating agencies had been aware of the company's problems for months. Some empirical studies have documented that yield spreads of corporate bonds start to expand as credit quality deteriorates but before a rating downgrade, implying that the market often leads a downgrade and questioning the informational value of credit ratings.This has led to suggestions that, rather than rely on CRA ratings in financial regulation, financial regulators should instead require banks, broker-dealers and insurance firms (among others) to use credit spreads when calculating the risk in their portfolio.

• Large corporate rating agencies have been criticized for having too familiar a relationship with company management, possibly opening themselves to undue influence or the vulnerability of being misled.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. Furthermore, because information about ratings changes from the larger CRAs can spread so quickly (by word of mouth, email, etc.), the larger CRAs charge debt issuers, rather than investors, for their ratings. This has led to accusations that these CRAs are plagued by conflicts of interest that might inhibit them from providing accurate and honest ratings. At the same time, more generally, the largest agencies (Moody's and Standard & Poor's) are often seen as promoting a narrow-minded focus on credit ratings, possibly at the expense of employees, the environment, or long-term research and development.^{[citation needed]} These accusations are not entirely consistent: on one hand, the larger CRAs are accused of being too cozy with the companies they rate, and on the other hand they are accused of being too focused on a company's " bottom line" and unwilling to listen to a company's explanations for its actions.^{[citation needed]}.

• While often accused of being too close to company management of their existing clients, CRAs have also been accused of engaging in heavy-handed " blackmail" tactics in order to solicit business from new clients, and lowering ratings for those firms . For instance, Moody's published an " unsolicited" rating of Hannover Re, with a subsequent letter to the insurance firm indicating that " it looked forward to the day Hannover would be willing to pay" . When Hannover management refused, Moody continued to give Hannover Re a rating, which were downgraded over successive years, all while making payment requests that the insurer rebuffed. In 2004, Moody's cut Hannover's debt to junk status, and even though the insurer's other rating agencies gave it strong marks, shareholders were shocked by the downgrade and Hannover lost $175 million USD in market capitalization.

• The lowering of a credit score by a CRA can create a vicious cycle, as not only interest rates for that company would go up, but other contracts with financial institutions may be affected adversely, causing an increase in expenses and ensuing decrease in credit worthiness. In some cases, large loans to companies contain a clause that makes the loan due in full if the companies' credit rating is lowered beyond a certain point (usually a " speculative" or " junk bond" rating). The purpose of these " ratings triggers" is to ensure that the bank is able to lay claim to a weak company's assets before the company declares bankruptcy and a receiver is appointed to divide up the claims against the company. The effect of such ratings triggers, however, can be devastating: under a worst-case scenario, once the company's debt is downgraded by a CRA, the company's loans become due in full since the troubled company likely is incapable of paying all of these loans in full at once, it is forced into bankruptcy (a so-called " death spiral" ). These rating triggers were instrumental in the collapse of Enron. Since that time, major agencies have put extra effort into detecting these triggers and discouraging their use, and the U.S. Securities and Exchange Commission requires that public companies in the United States disclose their existence.

• Agencies are sometimes accused of being oligopolists, because barriers to market entry are high and rating agency business is itself reputation-based (and the finance industry pays little attention to a rating that is not widely recognized). Of the large agencies, only Moody's is a separate, publicly held corporation that discloses its financial results without dilution by non-ratings businesses, and its high profit margins (which at times have been greater than 50 percent of gross margin) can be construed as consistent with the type of returns one might expect in an industry which has high barriers to entry.

• Credit Rating Agencies have made errors of judgment in rating structured products, particularly in assigning AAA ratings to structured debt, which in a large number of cases has subsequently been downgraded or defaulted. The actual method by which Moody's rates CDOs has also come under scrutiny. If default models are biased to include arbitrary default data and " Ratings Factors are biased low compared to the true level of expected defaults, the Moody’s [method] will not generate an appropriate level of average defaults in its default distribution process. As a result, the perceived default probability of rated tranches from a high yield CDO will be incorrectly biased downward, providing a false sense of confidence to rating agencies and investors." Little has been done by rating agencies to address these shortcomings indicating a lack of incentive for quality ratings of credit in the modern CRA industry. This has led to problems for several banks whose capital requirements depend on the rating of the structured assets they hold, as well as large losses in the banking industry. AAA rated mortgage securities trading at only 80 cents on the dollar, implying a greater than 20% chance of default, and 8.9% of AAA rated structured CDOs are being considered for downgrade by Fitch, which expects most to downgrade to an average of BBB to BB-. These levels of reassessment are surprising for AAA rated bonds, which have the same rating class as US government bonds. Most rating agencies do not draw a distinction between AAA on structured finance and AAA on corporate or government bonds (though their ratings releases typically describe the type of security being rated). Many banks, such as AIG, made the mistake of not holding enough capital in reserve in the event of downgrades to their CDO portfolio. The structure of the Basel II agreements meant that CDOs capital requirement rose 'exponentially'. This made CDO portfolios vulnerable to multiple downgrades, essentially precipitating a large margin call. For example under Basel II, a AAA rated securitization requires capital allocation of only 0.6%, a BBB requires 4.8%, a BB requires 34%, whilst a BB(-) securitization requires a 52% allocation. For a number of reasons (frequently having to do with inadequate staff expertise and the costs that risk management programs entail), many institutional investors relied solely on the ratings agencies rather than conducting their own analysis of the risks these instruments posed. (As an example of the complexity involved in analyzing some CDOs, the Aquarius CDO structure has 51 issues behind the cash CDO component of the structure and another 129 issues that serve as reference entities for $1.4 billion in CDS contracts for a total of 180. In a sample of just 40 of these, they had on average 6500 loans at origination. Projecting that number to all 180 issues implies that the Aquarius CDO has exposure to about 1.2 million loans.) Pimco founder William Gross urged investors to ignore rating agency judgments, describing the agencies as " an idiot savant with a full command of the mathematics, but no idea of how to apply them."

• Ratings agencies, in particular Fitch, Moody's and Standard and Poors have been implicitly allowed by governments to fill a quasi-regulatory role, but because they are for-profit entities their incentives may be misaligned. Conflicts of interest often arise because the rating agencies, are paid by the companies issuing the securities — an arrangement that has come under fire as a disincentive for the agencies to be vigilant on behalf of investors. Many market participants no longer rely on the credit agencies ratings systems, even before the economic crisis of 2007-8, preferring instead to use credit spreads to benchmarks like Treasuries or an index. However, since the Federal Reserve requires that structured financial entities be rated by at least two of the three credit agencies, they have a continued obligation.

• 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. The strength of the CDO was not wholly dependent on the strength of the underlying loans, but in fact the structure assigned to the CDO in question. CDOs are usually paid out in a 'waterfall' style fashion, where income received gets paid out first to the highest tranches, with the remaining income flowing down to the lower quality tranches i.e. < AAA. CDOs were typically structured such that AAA tranches which were to receive first lien (claim) on the BBB rated loans cash flows, and losses would trickle up from the lowest quality tranches first. Cash flow was well insulated even against heavy levels of home owner defaults. Credit rating agencies only accounted for a ~5% decline in national housing prices at worst, allowing for a confidence in rating the many of these CDOs that had poor underlying loan qualities as AAA. It did not help that an incestuous relationship between financial institutions and the credit agencies developed such that, banks began to leverage the credit ratings off one another and 'shop' around amongst the three big credit agencies until they found the best ratings for their CDOs. Often they would add and remove loans of various quality until they met the minimum standards for a desired rating, usually, AAA rating. Often the fees on such ratings were $300,000 - $500,000, but ran up to $1 million.

• It has also been suggested that the credit agencies are conflicted in assigning sovereign credit ratings since they have a political incentive to show they do not need stricter regulation by being overly critical in their assessment of governments they regulate.

• Rating agencies have come under criticism for a narrow-minded view of government default from investors' perspective. A government that does not run a sustainable budget might be forced to print money to meet credit payments, this will then inflate the economy and devalue the currency. USA is for example thought to be unlikely to default on their payments since they have the printing power of the dollar, which a country like Greece does not have for its currency, the Euro. However the Euro, which was introduced in year 1999 on an even exchange rate with the dollar, was trading almost 50% higher than the dollar only 10 years after its launch. At that time, because of investor fear for a default in the peripheral states of EU, Greece's government bond credit rating was in the junk bond category, while the USA credit rating was still in the top category. The criticism escalated in summer, 2011, when the European Commission and EC President and former Portuguese premier José Manuel Barroso, respectively, criticized Moody's downgrade of Portuguese bonds

• After Moody's reported a surge in " toxic" municipal debt (money owed to banks by municipalities) in China in summer, 2011, Bank of America Merrill Lynch economist Ting Lu deemed the assessment “too pessimistic," saying he disagreed with the assumptions and the math and the translation-of-terms used by the rating agency. Moody's had also estimated that " between 8% to 12% of loans extended by Chinese banks could eventually be classed as non-performing," according to a news report.

iPunter      ( Date: 14-Jul-2011 12:00) Posted: This is a very profound aspect of stock market education.     Stocks play is ironically not so much about stocks.               It is more about human psychology. And this is played                       out clearly in stocks play. Human ego is such that it                               wants to be right. If the market proves them wrong,                                       they will be " mm kam guan" (a maiifestation of ego)...                                               So as a result, they average up and average down,                                                       and feeling either extremely confident, or angry,                                                               but not feeling both at the same time...