Credit Rating Agencies Raise Concerns Apropos Their Veracity
Credit rating agencies assign grades to bonds that signify a mark of financial soundness and regularity in interest and principal payments. The ratings range from AAA for the highest quality bond instruments to BBB for medium quality bond instruments to CCC for low quality bond instruments, and D for instruments in default. They also have various sub ratings within them. These ratings are regularly updated and published in various investment sites and blogs.
An interesting article by Tara Perkins & Boyd Erman titled "Misguided or Misunderstood?" mentions the history of credit rating agencies. They originated in the 1860's when Henry Varnum Poor and his son Henry William Poor published the Manual of Railroads of the United States. Followed by John Moody in 1910, who began analyzing railroads and assigning ratings to them. Soon after, in the 1930's, it was established that ratings must be assigned to bonds and commercial papers.
Should an investor reckon wholly and solely on credit ratings to sift off performing funds from under-performing laggards? Whilst credit ratings can be good indicators as to the performance, risk and relative safety of funds over a period of time, they must not be considered as the sole guide for culling out one's investments. This view is a take off from the recent controversy created by credit rating agencies over their alleged role played in exacerbating the current mortgage situation in the United States.
Worlds most respected and valued credit rating agencies- The likes of Moody's Fitch and Standard and Poor's are being put under regulators scrutiny for their misdemeanor in failing to send off adequate warning signals for the impending sub prime crisis and housing market downturn. Another credit rating agency recently in the limelight for its involvement in the commercial paper crisis in Canada is DBRS Ltd. This agency assigned high ratings to risky ABCP (Asset Backed Commercial Papers) which were pooled in mortgages financed by commercial papers.
It is quite interesting to note that these agencies derive their revenues from the same companies that they rate. In this light they could be subject to a certain degree of conflict in interest. The agencies have been subject to SEC supervision since last year over their role in the housing market downturn. Being "Rating Agencies" that are into the sole business of grading funds of "Investment Grade" they should have seen the crisis coming and rung the warning bells way in advance.
Investors then and now have a significant amount of faith attached to these ratings and perceive them as infallible. A lesson from the situation is not to blindly rely on the ratings and invest. What is quintessential however, as reiterated time and again, is to assiduously scrutinize one's investments and do one's research before investing.