Credit Rating Agencies And The Financial Crisis.

September 15th 2008 will be remembered in financial circles as the 9/11 of the global financial system.This was the day Lehman Brothers filed for Chapter 11 bankruptcy protection.
While the world struggles to control the economic free-fall it is now being accepted that the financial crisis was triggered by a credit crisis which in turn was sparked off by a crisis of confidence.Lack of confidence in what?Wall Street's expansion over the last decade was fueled by innovative financial products.Loosely regulated investment banks called the shots,and so successful were they in making money that regular old fashioned banks set up similar enterprises or participated in this misadventure through 'off balance sheet entities', in order to avoid regulatory scrutiny.
How was it that these novel financial products or 'toxic assets' as they are now called became the preferred investment over other time tested financial assets?Quite simply it was a period of unprecedented financial expansion,a time when risk taking was fashionable and to give a very old explanation 'bad money' simply drove out the 'good money' from the system.Had all the experienced bankers with degrees from fancy Ivy League institutions gone collectively blind all of a sudden?Not at all.It is here that the role of the supposedly reliable rating agencies becomes questionable.By rating products as AAA, Aa1 etc. they induced innocent investors to gobble up these toxic assets.The poor investor paid a heavy price for relying on the supposed objectivity and integrity of these credit agencies.The extent of betrayal becomes clearer when you consider that it is legally binding on insurance companies and money market funds to invest only in assets which enjoy the highest rating given by a few Nationally Recognized Statistical Rating Organizations or NRSRO's. Amongst the best known are S&P,Moody's,Fitch etc.
While various probes have been ordered into the activities of investment banks none of these agencies have been touched.It must be understood that these agencies are as guilty as the investment banks because they were paid by these banks to rate their products.In brief they had a vested interest in the various offerings going through.Interestingly Moody's, probably the most successful rating agency over the last few years,is almost 20% owned by Warren Buffet's Berkshire Hathaway.
Bringing about greater transparency in the working of these agencies is the need of the hour and what better way to do so than asking them to make public the information on which their rating is based.Till such time the SEC makes such a rule investors risk being taken for a ride by an unscrupulous or careless rating agency.