Analysis Of Moody's Credit Rating Case Study

Category
Subcategory
Topic
Words
1761 (4 pages)
Downloads
45
Download for Free
Watch out! This text is available online and is used for guidance and inspiration
Download PDF

In 2008, the American markets started to disintegrate because of frenzied and unethical, if not illegal, dealing in home loans. Investment companies and banks failed or were sold, credit became impossible to obtain and everyone was afraid to loan or borrow money. Jobs became scarcer, interest rates soared, and people could not afford their house payments – foreclosure became a word etched into everyone’s vocabulary.

People began taking a closer look at those firms responsible for evaluating and rating the risks involved with investments, and it revealed that all was not well, and had not been for some time. Founded in 1909, for many years, Moody’s had rated thousands of bonds created from bundles of home loans to people with low incomes and poor credit histories, called “sub-prime”, who were purchasing homes they could not afford once the flexible interest rate they signed on for went up. Since Moody’s was the oldest and most trusted of the ratings firms, no one thought twice about their ratings – which were falsely inflated. This trust started as a huge risk and ended with the near ruin of the American financial system. It is no surprise that Moody’s itself was the biggest winner in this game. For those five years, Moody’s beat out everyone on the S&P 500, including giants like Exxon and Microsoft, to have the highest profit margin. As a result, the company’s shareholders and top executives reaped many benefits. Forbes magazine reported that Moody’s chairman and CEO earned total compensation (salary, stock, bonuses) of 7. 4 million.

Others who profited included foreign governments like China, India, Saudi Arabia and the United Arab Emirates (UAE). They were able to set up large stockpiles of goods to sell globally. Also, large pension plans, those saving for their golden years of retirement and private hedge funds. Once the bubble burst and people were not able to make the payments, the investors sometimes realized that they had lost big by gambling on the sub-prime mortgages. The biggest victims were the borrowers themselves. Although they should have had plenty of opportunities to review what they were signing up for, the contracts were in legalese. Many lenders and their employees intentionally misled the borrowers because the pressure was so high to create loans. Moody’s had a huge conflict of interest, one that violated even their own ethics – a Moody’s VP stated in 1957, “We obviously cannot ask payment (from the issuer] for rating a bond,” he wrote. “To do so would attach a price to the process, and we could not escape the charge, which would undoubtedly come, that our ratings [were] for sale. ” The Principles in this conflict were primarily the bond issuers, who had a significant interest in getting the best possible ratings and were willing to pay for it. Better ratings mean a better market value so all the more they could sell it for. Because of its perceived trustworthiness and long history, Moody’s became the Agent in the conflict. They sought to increase their own yield by catering more to their clients. The sub-prime loans that were being bought and sold in pieces or bundles were more complicated, so they could charge more for the rating. This also meant better returns for the shareholders. Historically, part of Moody’s business tactics also included rating bonds they were not asked or paid to rate. They had been doing it since the company’s inception in 1909. This did not sit well with bond issuers, especially when it cost them money. However, after the 2008 financial crisis, the SEC adopted new rules for the rating agency industry, including one to encourage unsolicited ratings.

The aim is to prevent potential conflicts of interest in the issuer-pays model. (Federal Register) Also, the system for rating bonds should be clear and consistent across all agencies. Anyone who wishes to look for the best way to invest their money will be able to understand exactly why the rating is high or low. Moody’s was basically bribed to deliver higher ratings, so to keep their clients, and thus their stockholders, happy, they inflated the worth of thousands of bonds. Later, as the market began crumbling under the weight of so many exaggerated bonds, Moody’s began to downgrade these ratings, causing panic. This created a market based not in reality, but on top of a bubble – a bubble that was about to burst and send the whole system tumbling down a rabbit hole. Increased pressure from investors hungry for the quick, easy money these bundles seemed to be generating to provide the asset-based securities that were these sub-prime loans, the banks began to ignore the policies regarding who could have a loan and dropped their standards to a point that any person breathing, no matter their projected ability to pay, could get a loan for a home they could very obviously not afford. they saw $$, not people whose lives would be destroyed. Facing immense demand from executives and offered major bonuses, bank employees generated incredible numbers of loans. Some banks even paid real estate agents for bringing in borrowers. This is shaky legal ground and created a conflict of interest.

We will write a unique paper on this topic for you!
Place Order

*No hidden charges

The brokers who sold the most precarious loans made more money for the bank and its executives. They were lavishly rewarded for their work. These loans were based on the banks’ ability to force appraisers to pad property values and make the loans seem less dicey and easier to parcel and sell. The buyers themselves either knew they could not afford the home or were too uneducated to understand or did not even bother to read the contracts they were signing. The agents who made these sales made sure that the buyers stayed as ignorant as possible, so they would sign on the dotted line, adding another person to the victim list. This eagerness to lower the bar for making home loans was looked logical considering the policies at the time. Both presidents Clinton and Bush had created programs to help minority and low-income borrowers to obtain housing. Helping with various fees, closing costs and down payments as well as mortgages that were federally insured, the government was aiming on assisting first-time buyers. They went so far as to sponsor their own lenders – Fannie Mae and Freddie Mac – and pushed them to buy these loan packages.

Strong global growth, increasing capital flows, and protracted stability earlier in the decade, market participants sought higher yields without a satisfactory appreciation of the risks and blundered by not executing appropriate due diligence. Also, weak standards for subsidizing these loans, increasingly complicated and vague financial products and unstable risk management, combined to create in the system susceptibilities for failure. Policy-makers and managers in some countries did not sufficiently identify and address the risks beginning to build up in the global financial markets. (G20) Because of the prominence of these low-quality loans, the overseeing division for commercial banking institutions inside the Treasury Department, the Office of the Comptroller of the Currency began to discuss new rules in 2005. These orders would have restricted dubious contracts as well as made more explicit explanations to borrowers as well as cautioning those wanting to invest in the purchase of these speculative loans’ compulsory. Some state officials also tried to regulate the market better but the companies making the money, lenders and banks, protested mightily and argued that when the SEC changed the rules for ratings companies in 1975 it authorized the three most prominent companies – Moody’s, Standard & Poor’s and Fitch – as Nationally Recognized Statistical Rating Organizations, or NRSROs. This gave these companies the power to directly influence, even create, the regulations.

Thus, the feds invalidated the states’ attempts and acquiesced. As well as eliminating the designations as NRSRO’s to rein in the power of the ratings companies and eliminate the ability to charge the issuers of such bonds, there should obviously be regulations that prevent the creation of subprime loans at all. The guidelines for loaning someone such a large sum of money was there to prevent this sort of thing from happening to begin with. It is time to return to common sense. Although codes of conduct include regulations regarding the analysis of bonds by more than one person, the salaries of analysts not being based on commissions from the issuers of the bonds and the owning of stock in companies being evaluated, a permanent, dedicated oversight committee needs to be created. It should include people from the ratings companies, the lending institutions and the Treasury Department. This committee should have powers that include assessment, evaluation and consequences regarding the creation, rating and sale of the loans and the bundles they may be sold as.

Just as the OCC wanted to require in 2005, lenders need to be compelled to make clear and understandable all the language of the loan contracts before the borrower signs them and be able to prove that this was done, much like the HIPPA acknowledgements in the medical field. The investment rating companies, Moody’s as well as the others, have been doing their business for a long time. What they do, and how they do it creates giant ripples across global markets. They contributed heavily to the Great Recession by allowing themselves to be swayed more by client happiness than by objective reports. Later, they dumped the inflated ratings they had previously handed out, creating panic among investors and chaos in the markets – much like the runs on the banks in the 1930’s. During a town hall style meeting at Moody’s after the implosion of the markets, one managing director stated, “[W]hat really went wrong with Moody’s subprime ratings leading to massive downgrades and potential more downgrades to come? We heard 2 answers yesterday: 1. people lied, and 2. there was an unprecedented sequence of events in the mortgage markets. As for #1, it seems to me that we had blinders on and never questioned the information we were given. . . As for #2, it is our job to think of the worst-case scenarios and model them. Combined, these errors make us look either incompetent at credit analysis, or like we sold our soul to the devil for revenue, or a little bit of both. ” (original article) There were others who hold responsibility for the Great Recession – investors, managers, investment banks, mortgage companies and governments. They all contributed to an environment that did not seem to care about the eventual ramifications of the sub-prime lending, the fast profit was what mattered.

You can receive your plagiarism free paper paper on any topic in 3 hours!

*minimum deadline

Cite this Essay

To export a reference to this article please select a referencing style below

Copy to Clipboard
Analysis Of Moody’s Credit Rating Case Study. (2020, July 22). WritingBros. Retrieved October 20, 2021, from https://writingbros.com/essay-examples/analysis-of-moodys-credit-rating-case-study/
“Analysis Of Moody’s Credit Rating Case Study.” WritingBros, 22 Jul. 2020, writingbros.com/essay-examples/analysis-of-moodys-credit-rating-case-study/
Analysis Of Moody’s Credit Rating Case Study. [online]. Available at: <https://writingbros.com/essay-examples/analysis-of-moodys-credit-rating-case-study/> [Accessed 20 Oct. 2021].
Analysis Of Moody’s Credit Rating Case Study [Internet]. WritingBros. 2020 Jul 22 [cited 2021 Oct 20]. Available from: https://writingbros.com/essay-examples/analysis-of-moodys-credit-rating-case-study/
Copy to Clipboard

Need writing help?

You can always rely on us no matter what type of paper you need

Order My Paper

*No hidden charges

/