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The truth behind the great crisis: Why did the ratings of credit rating agencies fail during the financial crisis?
With the outbreak of the financial crisis in 2007-2008, the rating system of credit rating agencies (CRAs) was seriously questioned, and countless securities with the highest ratings fell to junk levels in just a few years, causing huge market losses. Why did these institutions, once seen as market stabilizers, fail at critical moments? This article will explore the historical background, operating mechanisms and reasons why credit rating agencies lost their credibility during the financial crisis.
Credit rating agencies theoretically reduce information costs by providing independent assessments, expanding the pool of potential borrowers and facilitating liquid markets.
Historical Background of Credit Rating Agencies
Credit rating agencies first appeared in the United States and originated from commercial credit reporting agencies in the 19th century. As the United States expanded westward, the distances of commerce increased, making it impossible for merchants to conduct individual assessments of their customers, and credit rating agencies came into being. In 1841, Louis Tappan founded the first credit rating agency in New York, and with the growing demand for financial transparency, these agencies began to assess the credit risk of companies and the bonds they issued.
Role in financial markets
Credit ratings typically affect the interest rate on a bond, with higher-rated bonds paying lower interest rates, making them an integral part of the investor and financial process. However, in recent decades, the main clients of credit rating agencies have shifted from investors to bond issuers, raising questions about conflicts of interest.
According to some studies, credit ratings are not as responsive as rating agencies suggest, and in the past credit rating agencies have failed to foresee many major financial crises.
Failure during the 2007-2008 financial crisis
During the 2007-2008 financial crisis, the failure of credit rating agencies became a hot topic of global debate. According to data, 73% of mortgage-backed securities rated AAA in 2006 were downgraded to junk level two years later. This phenomenon not only caused significant losses to investors, but also posed a long-term threat to the overall stability of the financial system.
Problems with the operating mechanism of rating agencies
The credit rating agencies' assessment process relies too much on information provided by issuers and lacks independent investigation and accurate market response. Even when there are significant changes in an issuer's financial condition, rating agencies often fail to adjust their ratings in a timely manner. In many cases, relevant rating changes are often made only after a corporate crisis occurs.
Future Outlook
As key players in the market, credit rating agencies need to respond to calls for reform. Maintaining their professionalism and transparency is key to regaining their credibility. In addition, the market needs to further improve the system and reduce its reliance on ratings from these agencies. Protecting investors' interests and reducing the risk of volatility in financial markets should be a long-term goal.
ConclusionIn the face of severe financial crises and market fluctuations, the performance of credit rating agencies has been put under the microscope, and future reform tasks are imminent.
Overall, the performance of credit rating agencies during the financial crisis revealed flaws in their internal operations and inadequate external supervision. Faced with such a complex environment, the market must reflect on the role and function of credit rating agencies to protect the interests of investors and reduce systemic risks. So, in the future financial system, what kind of reforms can make credit rating agencies regain trust?
