Endnotes

¹The same points are made in the Turner Review issued by the Financial Services Authority (2009: 76).

²The Issing Committee report makes a similar point, noting that ratings assigned to structured products are based on estimating the loss distribution of the underlying loan portfolio. These estimations rely on models that are not fully transparent to the industry. However, rating agencies provided “customer end” tools to their clients, which allowed banks to run pre-tests of their new securitization portfolios before submission to the agency. As a result, loan portfolios could be designed in a way that just met the criteria included in the relevant model, but may have additional risk pertaining to criteria not included in the model. As an example, consider information on whether first loss tranches are retained or not. Although we know that the sale of the so-called first loss piece lowers expected portfolio returns, this is not an explicit part of the rating model currently in use, and is therefore not reflected in the assigned rating. Hence, the issuer can raise its profits by selling first loss pieces, without disclosure to the investors. This gaming argument refers to structured finance products only, not to corporate bonds in general. The reason is that in structured finance, the tailoring of portfolio composition is feasible (easy, low cost), while it is infeasible (difficult, expensive) if the underlying asset pool is an entire corporation with its fixed assets (Issing Committee 2008).

³Senior notes of structured investment vehicles (SIVs), for instance, were often awarded high credit ratings on the basis that, if the asset value fell below defined triggers, the SIV would be wound up before senior note holders were at risk. At the system level, however, this resulted in attempted simultaneous asset sales by multiple SIVs, and the rapid disappearance of liquidity (both for asset sales and for new funding) as market value limits were triggered and ratings were cut (Financial Services Authority 2009).

⁴Credit default swaps and other over the counter derivative contracts entered into by AIG, for instance, required it to post more collateral if its own credit rating fell. When this occurred in September 2008, a downward spiral of increased liquidity stress and falling perceived creditworthiness rapidly ensued (Financial Services Authority 2009).

⁵See also the de Larosière Group report (2009: 16). “But the use of ratings should never eliminate the need for those making investment decisions to apply their judgement. A particular failing has been the acceptance by investors of ratings of structured products without understanding the basis on which those products were provided.”

⁶In a motion before the federal parliament of 15 November 2007, for example, the German Left Party (Die Linke) called for the creation of impartial, public-sector credit rating agencies (Deutscher Bundestag 2007).

⁷See Securities Exchange Acts of 1934 Art. 15E (2).

⁸The ten agencies: A.M. Best Company, Inc.; Dominion Bond Rating Service Ltd.; Fitch, Inc.; Japan Credit Rating Agency, Ltd.; Moody's Investor Services, Inc.; Rating and Investment Information, Inc.; Standard & Poor's Rating Services; Egan-Jones Rating Company; LACE Financial Corp.; and Realpoint LLC.

⁹For proposals on a far-reaching extension of CRA regulation, see also Partnoy (2009).

¹⁰In June 2009 the German Federal President demanded in a speech a European public rating agency. See Köhler (2009).

¹¹For an in-depth discussion of these problems and for concrete proposals, see Partnoy (2009) and Dittrich (2007).

Download this Paper [ PDF 169.2KB| 26 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.