Reflection of "The Credit Rating Controversy" Finance Essay

Reflection of "The Credit Rating Controversy"
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Reflection of "The Credit Rating Controversy"
Article Name: The Credit Rating Controversy
Authors: James M. Lindsay and
Publication: Council on Foreign Relations
Rating agencies are expected to give comfort regarding the ability of an issuer to repay a debt. Ratings are critical because they assist in determining the level of interest that a borrower should pay. When Rating agencies issue inaccurate ratings, the move distorts the prices of debt instruments and the interest rates payable on them. Over the years, inaccurate ratings have led to asset bubbles that ultimately burst, hence interfering with the operation of the financial markets.
In this article, the Council of Foreign Relations (CFR) highlights the contribution of the “Big Three” global credit rating agencies i.e. Standard and Poor’s (S&P), Moody’s, and Fitch Ratings financial crises over the years. Firstly, the authors indicate that while the three rating agencies are expected to advise investors regarding the riskiness of different types of debt, they have resulted in exacerbating the financial crisis. The inability of the agencies to offer favorable evaluations regarding the solvency of financial institutions has led to the approval of extremely risky mortgage-related securities (Lindsay & Steil, 2015). Secondly, the authors indicate the shortcoming of the “issuer-pay” business model used by the rating agencies. Here, the institution being rated caters for the rating costs. The ratings are made accessible to the public and investors free of charge. The investors them to use the ratings to make investment decisions. Before 1970s, the model used was “subscriber pay” where investors paid for the ratings (Lindsay & Steil, 2015). Furthermore, the “Big Three” rating agencies have monopolized the industry. The monopolization has made the environment uncompetitive. This forced investors t rely on the few alternatives available.
The authors indicate that the “issuer-pay” model used by the rating agencies is flawed. Since institutions being rated pay these companies, there is an inherent conflict of interest. While this has been evident in the various crises, especially the 2008 financial meltdown, the regulatory mechanisms have been unable to address the issue (Lindsay & Steil, 2015). The authors allege that despite these weaknesses, the three rating agencies continue to be referenced in key financial market decisions. Additionally, the article indicates...