Samenvatting:

This paper analyses credit rating agencies as one example of a ‘private authority’ involved in the governance of financial markets.

Nuttige Stukken:

These risk assessments are widely used for making investment decisions in the market place.private credit ratings have been used to make the regulation of financial market risk sensitive – for example – by restricting the investment activities of banks to instruments of low credit risk P5

rating agencies almost never have to justify their decisions, let alone provide compensation to others for the adverse consequences of their mistakes. The breach between the magnitude of potential damages for borrowers and the possibilities of a remedy gives rise to an ‘accountability gap’. P5

Rating agencies have not been exploiting the informational asymmetry between themselves and their users. The  reason is that information intermediaries are seen to be particularly vulnerable to a loss of reputation as credible sources of information (Mann 1999). Yet, monitoring by reputation can be less effective in times of financial crisis, when rating agencies start to copy each other in order to avoid being the only one off the mark (Kuhner n.d.). P7

Second, it is doubtful whether the power of the rating agencies can be explained solely by the fact that there is no alternative to their credit risk assessments. In fact, alternative sources of information on credit do exist, such as credit registers and export credit ratings (Estrella et al. 2000: 55-125). Beyond that, a wide range of sources exist that produce credit-related knowledge; for example, investment funds, banks, professional associations and even academia. P8

the accountability gap is a problem because it prevents the correction of errors, not because of a hidden ideological agenda P12

As a rule, the rating of a borrower will not be higher than the rating of the country of origin. Second, ratings depend on some properties of the borrower himself. For any type  of firm, credit-worthiness depends on the ratio of firm value to outstanding debt (Gordon 1991). The higher the value of a firm’s assets, the higher the income flows and the lower all debt obligations, the higher the credit rating is going to be….assess the stability over time and the likelihood of a declining performance under stress… P13

Rating agencies and other institutions are not distinguished for publishing their analyses of credit-worthiness ... The claim is thus that ratings allow a comparison of the credit-worthiness P14

What is more, rating decisions always have a qualitative side that is impossible to formalize P15

Since the regulatory use of ratings seeks to curb excessive risk-taking, it targets the investors or borrowers….Thus, in order to avoid being excluded from the credit market, lenders have a strong incentive to observe the rating agencies standard of credit- worthiness. Thus, in order to avoid being excluded from the credit market,

lenders have a strong incentive to observe the rating agencies standard of credit-worthiness.P19

An accountability gap arises whenever there is a breach between the power of a rule-maker and the possibility to attribute blame. P22

Certainly rating agencies decline any responsibility for their decisions: they maintain that their information on credit risks cannot pre-empt financial decision-making but only guide it (McGuire 1991: 83).6 There are a number of good reasons for this stance. First, investment decisions always have to be related to the entire portfolio. A security with a low credit rating is not necessarily a bad investment, since it promises a higher yield. Second, investment decisions inevitably comprise other risks beyond mere credit risk measured by the credit rating. Additional risks such as exchange-rate risks with foreign investments or liquidity risks are not included in a rating. P22

Limited Liability

Limited Competition

Limited Supervision

In times of crisis, changes of credit ratings seem to have a pro-cyclical effect on the dynamics of financial markets and thus aggravate rather than stabilise a crisis (Adams et al. 1999: 186). P27

18-07-2009 om 23:20 geschreven door pieter

Samenvatting:

Nuttige stukken:

There are some features that are unique to this crisis, such as the transfer of assets from the balance sheets of banks to the markets, the creation of complex and opaque assets, the failure of ratings agencies to properly assess the risk of such assets, and the application of fair value accounting P3

Two serious problems arise with the practice of structured finance. The first regards the incentive of the originator to screen debtors when the loans are destined to be placed off balance sheet. Reputational considerations would suggest that the originator would not want to compromise its standards. However, the fact that regulators and accounting standards required little disclosure about unconsolidated off-balance sheet entities made these entities opaque to investors and lowered the cost of reputational loss to the sponsoring institution. P9

Implications of Fair Value accounting: The first is that unrealized gains and losses impact owners’ capital. The second is that, like for any other accounting rule, fair valuation provides incentives to management to game the rules to boost earnings (or reduce losses) and management bonuses linked to earnings’ performance. Thus, during periods of rising asset prices, the incentives will be to move assets into the trading account categories, and conversely during declining asset prices. The third is that when markets become less liquid, valuation models based on internal information become more relevant than valuation models based on observables and the latter more relevant than the use of unadjusted quoted prices. In the presence of patently illiquid markets, an argument can be made that fair values should be based on reliable estimates of future net cash flows. Finally, the pro-cyclical bias of fair value accounting tends to magnify current financial trends and, consequently, exacerbates a financial crisis (Wallison 2008). Lower accounting asset values that impact on regulatory capital may trigger management to sell in illiquid markets. P13

Ander bruikbaar materiaal:

Errors in judgment were as glaring as assigning the same letter grade to a CDO and a corporate bond with sharply different default rates.6

Calomiris (2007, p. 19) quotes from the Bloomberg Market of July, 2007 that CDOs rated Baa by Moody suffered five-year default rates of 24 percent, whereas corporate bonds with the same rating had default rates of 2.2 percent.

14-07-2009 om 00:00 geschreven door pieter

14-07-2009 om 00:00 geschreven door pieter