Did Credit Rating Agencies Do Good Work - Research Paper Example

DID СRЕDIT RАTING АGЕNСIЕS DО GООD WОRK? By Name Course Professor University City/State Date Abstract The last financial crisis 2007-2009 came as an eye opener to many on the credibility and reliability of credit rating agencies and whether these agencies are delivering their key mandates and duties. The question sometimes arises as to why a potential issuer would be willing to pay rating agencies tens of thousands of dollars in order to receive a rating, especially given the possibility that the resulting rating could be less favorable than expected. To many, the global financial crisis is a reason enough that the credit rating agencies have considerably failed in achieving their full mandate and were partially involved in causing the global financial crisis. To clearly bring out the purpose and roles of these credit rating agencies as well as their association, if any, with the global financial crisis, this paper will utilize a mixed study of both primary and secondary data to try and answer some three basic questions that will truly reveal the performance of these agencies at the height of the financial crisis and even after. The paper will discuss what these agencies are and their role in the global economy, their association with the financial crisis 2007-2009 and possible causes and consequences of the crisis, particularly on the economy of Qatar. Introduction-Background The financial crisis that came with the American mortgage subprime market in the year 2007 ended up having immense social as well as economic consequences across the globe (Bloom, 2011). In this regard, scholars, regulators, lawmakers, and other business leaders began to question the role played by credit rating agencies in the global economy and their hand in such market tumult (Johansson, 2010). This even resulted to a consensus across the globe led by the Group of Twenty or G20 that a regulatory intervention was required to ensure that the activities of the few Credit Rating Agencies operating in the international market were subjected to some effective oversight (Levich et al, 2002; Garcia Alcubilla & Ruiz del Pozo, 2012). As a result, credit rating agencies particularly the leading ones Standard & Poor’s, Moody’s, as well as Fitch have been featured in different debates associated with the global economy ever since the global financial crisis (Garcia Alcubilla & Ruiz del Pozo, 2012). The question sometimes arises as to why a potential issuer would be willing to pay rating agencies tens of thousands of dollars in order to receive a rating, especially given the possibility that the resulting rating could be less favorable than expected. This research paper seeks to analyze and establish what credit rating agencies are as well as their role in relation to the global economy. The research will also seek to establish if the credit rating agencies actually triggered or played a role in the global financial crisis. Additionally, the paper will also seek to establish the reasons behind the credit crunch (the last financial crisis 2007-2009) and its implications on Qatar’ economy. Addressing each of these issues will assist in addressing the topic of this research and answering the overall question of whether the credit rating agencies did some good work in relation to what unfolded in the last financial crisis. Literature Review Definition of Credit Rating Agencies and Their Role in the Global Economy The main role of credit rating agencies, to be precise, is to ensure provision of an appraisal of the probability that a borrower will default on either all or part of its loans or debts (Unterman, 2009). As a result, credit rating comprises of an index or manifestation of the creditworthiness of a given individual, institution, or even country (White, 2009; Levich et al, 2002). Creditworthiness is normally measured in some standard ratings that are normally used by the three key credit rating agencies that are known across the globe and they range from AAA/Aaa which is the highest grade to D (meaning default) which is the lowest (White, 2009 & Langohr & Langohr, 2008). Scoring high in the credit ratings is very important and it has a great influence on the organization or body that has been rated since it has a direct effect on its cost of borrowing. This is due to the fact that the ratings on each institution are usually considered by the various actors in the financial market when it comes to the making of crucial investment decisions. Institutions with high credit rating are normally seen as creating minimum risks for investors and therefore can easily obtain credit as well as at low interest rates as considered to those organizations whose credit ratings are low. This means that for an organization that has low credit rating, raising capital with the use of issuing bonds becomes very expensive or totally impossible (Levich et al, 2002). As noted by Langohr & Langohr (2008), the role of credit rating agencies has risen over the years to what it is today. Actually, in the contemporary financial markets, it has become very hard for any firm or organization to put any form of debt instrument in any open market not including a credit rating, particularly due to the fact that ratings are fundamental requirements for different regulations that govern investment policies used by pension funds and banks (White, 2009). Of course these credit ratings have to be produced by officially recognized credit rating agencies and for a long time, only three of these agencies have dominated the global market and they are Standard & Poor’s, Moody’s, as well as Fitch (Garcia Alcubilla & Ruiz del Pozo, 2012; Levich et al, 2002). Whether Credit Rating Agencies Actually Triggered or Played A Role in the Global Financial Crisis As exemplified by White (2009), the credit rating agencies started to rate a increasing number of multifaceted mortgage-and consumer credit-related instruments, plus associated new credit derivatives. Actually, according to Unterman (2009), over 50% of the revenues generated by Moody’s in the year 2006 were from rating such prearranged finance products. It is the venture of credit rating agencies into this market segment of complex instruments that had just been formulated a few years before the financial crisis that resulted to these agencies being associated with triggering of the global financial crisis. The fact that these credit rating agencies involved themselves in rating the new complex instruments resulted to them playing a key role in the establishment of the sub-prime bubble that eventually led to the financial crisis 2007-2009 (Unterman, 2009). By the end of the year 2008, financed securities that were structured consisted of more than $11 trillion in terms of the value of the U.S. bond market debt that was outstanding. The vast majority of these securities had been largely rated by the few credit rating agencies that were officially recognized (SAUNDERS & ALLEN, 2010). Over 50% of the structured finance securities that had been rated by Moody’s had been given a rating of AAA, which is the utmost possible kind of rating. In the year 2007 as well as 2008, structured finance securities had their creditworthiness deteriorate in a dramatic change and over 35, 000 tranches that had been rated by Moody’s got downgraded and amongst these that were downgraded over 30% of them had an AAA rating (NANTO, 2009). It is as a result of this that structured finance has been blamed some scholars and practitioners as having played a major role in the global financial crisis. It is clear that the investors trusted the credit rating agencies extremely, who frankly, got it wrong. And this explains why, they too, have also been blamed as having played a part in causing the financial crisis (SAUNDERS & ALLEN, 2010). Reasons for the credit crunch (the last financial crisis 2007-2009) and its implications on Qatar’ economy The financial crisis 2007-2009 kicked off with a credit crunch in 2007 after there was a loss of confidence among US investors, regarding the sub-prime mortgages’ value hence causing a liquidity crisis (Tsanis, 2010). This forced the US Federal Bank to inject a huge amount of investment or finances into the financial markets. A year later, things had gone much worse with the crisis spreading out to other economies and stock markets across the globe had now crashed as well as becoming extremely volatile. This resulted to a huge loss in consumer confidence in different areas across the globe as people prepared themselves for the worse in the coming future (Kolb, 2010). Though there are a wider range of other causes of the global financial crisis that have been suggested by different scholars and researchers, it is highly believed that the collapse of the housing sector in the United States was the greatest trigger of this crisis (Kolb, 2010; Tsanis, 2010). This has been referred to as the sub-prime crisis as well as the housing bubble in the United States. Back in 2007 and before then, the US housing market was hardly hit as lots of home-owners who had benefited with sub-prime loans could not repay their mortgages. As the home’s value plunged, the borrowers faced a crisis as their realized that they had negative equity. This resulted to a huge of loan defaulters since most of the borrowers could not be able to repay the loans and hence the banks had no other choice but to reposes the houses and lands. However, the big problem was that the reposed houses and lands had greatly dropped in terms of value and were worth too little in regard to the market prices at that time as compared to the value the bank had originally loaned them out. This resulted to a huge liquidity crisis for the banks and this resulted to huge difficulty in regard to giving out or even obtaining loans, following the bursting of the sub-prime lending bubble (Tsanis, 2010). Just like any other economies across the globe, the economy of the Arab world including that of Qatar was largely affected by the global financial crisis. According to UNITED NATIONS (2009), one of the greatest concerns in Qatar at the height of the global financial crisis was the declining prices of crude oil as well as the deceleration in regard to the growth of global economy. Qatar and other countries in the Arab region were affected by the spillover impacts of the last financial crisis 2007-2009 (GEOLOGICAL SURVEY, 2011). Nonetheless, as noted by Oxford Business Group (2010) in a report, the impact and degree were different depending on the country as well as the sectors of the economy. This is because each country has unique political, economic, geographical, demographic, cultural, and social features. Though the impact on the Qatar’s economy was not largely felt, the fall in the global demand that consolidated in the year 2009 had key repercussions in different sectors, regarding the economy of Qatar (Oxford Business Group, 2010). In addition to the investment strains following the collapse of the international finance, the prices of hydrocarbons and that of oil was greatly affected and it dropped. Furthermore, there was a reduction of the exchanges internationally and this impacted heavily on the economy of Qatar since it affected tourism, remittances, and exports among others. However, apparently Qatar was one of the countries that were not greatly affected by the global financial crisis in the whole of Arab world. Qatar, being a leading exporter of liquefied natural gas internationally, did not feel the effect of the financial crisis as much as it was felt in other countries across the Arab world (Oxford Business Group, 2010). Research Objectives and Research Questions Research Objectives To define and understand what credit rating agencies are and the role they play in the global economy. To find out if the credit rating agencies actually triggered or played a role in the global financial crisis. To establish the reasons behind the credit crunch (the last financial crisis 2007-2009) and its implications on Qatar’ economy. Research Questions What are credit rating agencies and what is their role in relation to the global economy? Did credit rating agencies trigger or play a role in the global financial crisis? What were the reasons for the credit crunch (the last financial crisis 2007-2009) and what were its implications on Qatar’ economy? Research Design (Methods and Methodology) This section is based on the manner, in which the study was executed, particularly the qualitative and quantitative methods that were used. In regard to the research design that was used for this research, both primary and secondary data sources were used to answer the fundamental research questions in this study. While such sources as oral interviews constituted or yielded primary data, secondary data was obtained from online/internet sources such as electronic journal articles and library sources such as books plus other publications. Therefore, the research design was constituted of any one method that the researcher believed was dependable in gathering the helpful data for the study. Data Collection and Analysis Methods of Data Collection Primary Sources The main primary sources of data that were relied upon in this study included the use of oral interviews. The researcher purposely selected the various professional respondents who were to play a major role in data provision and these came from different applicable sources. The respondents included senior staffs/employees in key public financial sectors as well as in the private businesses/institutions. Other respondents included representatives of the credit rating agencies. The sample size was 100 respondents and it had a fair distribution in terms of sex, age, and the institution they worked for. Banking senior officials from different banks were 40 out of the 100. 20 of the respondents were lecturers working in leading universities while the other 40 of them were sourced from different institutions operating in different sectors of the economy, including government officials. The respondents were either interviewed through an interview guide or issued with questionnaires to fill. The questionnaires and interview guides consisted the same set of questions and this made it easy for the analysis of the results. Interviews Interviews played a major role in the study because they assisted the researcher to collect data through inquiry, particularly for the professionals who were either extremely busy or those who did not like filling out the questionnaires by themselves. A total of 48 respondents out of the 100 preferred being interviewed at their convenient times rather than being left with questionnaires to fill them at their own free time, but within an agreed deadline. Survey (Questionnaires) The questionnaires were issued to the remaining 52 respondents who were not comfortable being interviewed. The researcher ensured that they understood how to fill out the questionnaire and left it with them after agreeing on a specified deadline when the questionnaires were to be collected. However, out of the 52 questionnaires issued, 6 of them were never returned and these respondents either had not filled them by the deadline or some had misplaced them. In addition, 4 of them were either filled incompletely or inaccurately making it hard for the researcher to pick out the actual responses by the respondents. This meant that a total of 10 questionnaire sheets were lost and hence the only 42 questionnaires were used to provide the data used for the analysis. Secondary sources Information or materials from a variety of secondary sources were used, particularly in coming up with the literature review section of this research that was also meant to address each of the research questions/objectives in this study. This comprised the internet, particularly for the electronic articles and eBooks as well as other library sources. The data obtained from the primary sources was supplemented using different publications such as books and journal articles on the topic of this study. There is no doubt that theoretical research requires that the various literatures varying from publications, books, journals, plus any other literature be deeply looked into to source any important data, as it was the case in this particular study. Data Analysis It was anticipated that towards the end of the study period, the researcher would have gathered adequate information regarding each of the research questions that was outlined in this research. Furthermore, the researcher would have obtained a variety of data both from credible primary and secondary sources of data. Afterwards, a descriptive analysis based on the association of the primary sources data obtained from the interviewees and information recorded in a wide range of secondary sources perused during the review of literature would be examined and analyzed decisively to come up with final answers to the research questions and the topic of the study in general. Analysis Having conducted the literature review as well as the various interviews with professionals and scholars in different sectors including the credit rating agencies, banks, and government sectors, the data obtained was arranged properly and sorted out alongside the main research questions and/or objectives. This was done in order to compare the correlation between the primary and secondary data. The data was arranged in accordance to each question and compiled together to obtain a satisfactory answer to each of the questions. Of course there were some conflicting views, particularly in regard to the interviews but these were well analyzed using the majority views. However, even the conflicting views were arranged together and compiled together because they could act as a basis for future studies to clarify some of the contentious issues where there was no consensus. In regard to the primary data, it is important to note that the response rate of the interviews and surveys combined was 90 out of 100. First, in regard to the definition of the credit agencies and the role they play in the global economy. All the 90 respondents had a definition for these agencies and majority of these responses were more or less similar. Nonetheless, the most notable thing is the fact that each of the respondents associated credit rating agencies with determination of the credit worthiness of a given organization. In regard to the question on whether the respondents believed that the credit rating agencies played an important role in the global economy, 60% of them strongly agreed and 40% of them just agreed with some reservations. For the ones who agreed, they gave their view on why they did not strongly agree with this and according to majority of the respondents, the credit rating agencies have lost their credibility following their perceived role in the last financial crisis 2007-2009. Majority of respondents also believed that while these agencies charges lots of money for rating, they are not as effective as expected in their ratings. Interestingly, all the respondents agreed that, it is near to impossible for any given organization to introduce any debt instrument into the market without an officially recognized credit rating. This together with the fact that the three major rating agencies enjoy an oligopoly across the globe may have compromised on the quality of services that these agencies give. In regard to whether these credit agencies were involved or triggered the global financial crisis, it is clear that this is still a conflicting issue that has scholars, researchers, and practitioners argue on either side, while majority belief it actually played a partial role because there were many other possible causes of the global financial crisis. According to 80% of the respondents, the involvement of the credit rating agencies with the multifaceted mortgage-and consumer credit-related instruments that eventually linked up with the global financial crisis was the major reason why these agencies were associated with that. 45% of the respondents cited the failure by the rating agencies to recognize the risky aspect in the new financial instruments that were created before the crisis and though they were hard to evaluate and shifted responsibility between agents, the agencies gave these instruments very high ratings. Additionally, 60% of the respondents claimed that the rating agencies, particularly Moody’s misled the investors who extremely trusted them and committed their cash into investments even though they seemed to have made a poor judgment. In this case, it is clear that these agencies did not perform their duties and responsibilities as it should have been and this is the reason why they did not anticipate or predict the global financial crisis. Lastly, the respondents had been asked to list the issues they believed triggered the financial crisis 2007-2009. Apparently, 90% of the respondents believed that the collapse of the housing sector in the United States or the sub-prime crisis as well as the housing bubble were the greatest contributors to the global financial crisis. In addition to these, a couple of other reasons were mentioned by respondents. 44% of the respondents believed that the 1980 DIDMCA (Depository Institutions Deregulation and Monetary Control Act) in the United States also played a major role in causing the global financial crisis. This is because this Act opened room for investment banks to establish lots of diverse financial instruments and this formed the basis of deregulation waves that followed. 38% of the respondents believed that the declining interest rate in the real market as well as the expansionary monetary policy by the Federal reserve were also to be blamed for causing the crisis. Nonetheless, it has also been argued that it was this low interest rate that contributed to the increased issuance of subprime mortgages. 25 % of the respondents also cited global financial imbalances as having contributed to the financial crisis. Finally, 15% cited the 1999 abolishment of the Glass-Steagall Act in the United States as having played a considerable role in the global crisis because it particularly allowed the banks to involve themselves in risky investments. Conclusion This paper was guided by a major topic/question on whether the credit rating agencies did a good work in regard to the last financial crisis 2007-2009. It would not have been easy to answer this question without analyzing what these agencies are all about and their roles, analyzing the global financial crisis and the role the credit rating agencies were playing at the time. Also, to understand the global financial crisis better it was necessary to analyze its causes and the implications it had on different economies across the globe, particularly in Qatar. The research design adopted was based on a mixed study of both primary and secondary data which were analyzed extensively to obtain reliable answers to the research questions. A lot of findings were made but the most important one is that despite the fact that credit rating agencies play a key role in the global economy, they had a hand in the last financial crisis and this is the reason why it has been suggested that they too need to be regulated. In this regard, this study has brought about a wide range of lesions. It clearly shows that it would be hard to operate without the credit ratings. However, unless these agencies are regulated, another financial crisis would be looming due to such issues as wrong rating of the credit worthiness of organizations, individuals, and countries among others. References Bloom, R 2011, 'The Financial Crisis Inquiry Report', CPA Journal, 81, 5, p. 6, MasterFILE Premier, EBSCOhost, viewed 15 December 2013. Garcia Alcubilla, R., & Ruiz del Pozo, J., 2012, Credit rating agencies on the watch list: analysis of European regulation. Oxford, Oxford University Press. GEOLOGICAL SURVEY., 2011, Minerals Yearbook Area Reports International Review, 2009, Africa and the Middle East. Geological Survey. Johansson, T 2010, 'Regulating credit rating agencies: The issue of conflicts of interest in the rating of structured finance products', Journal Of Banking Regulation, 12, 1, pp. 1-23. Kolb, R. W., 2010, Lessons from the financial crisis causes, consequences, and our economic future. Hoboken, N.J., Wiley. Langohr, H. M., & Langohr, P. T., 2008, The rating agencies and their credit ratings what they are, how they work and why they are relevant. Chichester, England, Wiley. Levich, R. M., Majnoni, G., & Reinhart, C. M., 2002, Ratings, rating agencies and the global financial system. Boston, Mass. [u.a.], Kluwer Academic Publ. NANTO, D. K. (2009). The global financial crisis: analysis and policy implications. Darby, Pa, Diane Publishing. Oxford Business Group., 2010, Qatar, 2010. [S.l.], Oxford Business Group. SAUNDERS, A., & ALLEN, L. (2010). Credit Risk Management In and Out of the Financial Crisis New Approaches to Value at Risk and Other Paradigms. Hoboken, John Wiley & Sons. Tsanis, K., 2010, The impact of the 2007-2009 subprime mortgage crisis in the integrated oil and gas industry. München, GRIN Verlag. UNITED NATIONS., 2009, The global economic and financial crisis regional impacts, responses and solutions. New York, United Nations. Unterman, Aaron J 2009, ‘Innovative Destruction: Structured Finance & Credit Market Reform in the Bubble Era’, Hastings Business Law Journal, 5, 1. White, Lawrence J 2009, ‘The Credit Rating Agencies and the Subrpime Debacle’, Critical Review, 21, pp.2-3. Appendix Questionnaire (Interview Guide) Instructions: Kindly give the information requested in this form with utmost truth, honesty and accuracy because it shall be treated as extremely confidential. Background information Gender……….. ……Date………………………..……………………………… Name of the Organization you work for…………………………………………. Position (Job Post)………………………………………………………………… Education Background (Expertise) ……………………………………………… Years of Experience ……………………………………………………………. Informant information 1. In the contemporary times potential issuers are willing to pay rating agencies tens of thousands of dollars in order to receive a rating, in your own understanding, what are these credit rating agencies? What’s your definition? …………………………………………… ………………………………………………………………………………………………………………………………………………………………………………………………….. 2. Credit rating agencies are said to play an important role in the global economy, what’s your view on this: Strongly Agree Agree Disagree Kindly explain your anwer ………………………………………………………………… ……………………………………………………………………………………………. 3. Credit rating agencies have been associated with the global financial crisis (the last financial crisis 2007-2009), do you think they played a role or triggered it in any way? Yes No If YES, how exactly did they trigger or play a role? …………………………………………………………………………………………………………………………………………………………… ………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………. If NO, kindly explain briefly ………………………………………………………………………………………………………………………………………………………….. ……………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………… 4. In your opinion and from experience, what are the issues you believe triggered the financial crisis 2007-2009 or the global financial crisis? ……………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………........................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................ 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