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Inflation of good grades


LONDON. It was just a small mistake somewhere in the computer program. Thousands of investors money but he has been so costly. Because of a programming mishap, the rating agency Moody’s has rated structured securities until 2007 much too well. Financial products worth several billion U.S. dollars were erroneously the top rating of "AAA", although they were actually much worse. Moody’s also the reputation of the competitors Standard & Poor’s and Fitch in the financial crisis suffered strong – because of such technical errors, but also because of systematic misperceptions. "We have our assumptions carefully located next to" Standard & Poor’s chief admits Deven Sharma.

The market for credit ratings has its own laws

How to avoid such problems in future? Financial market supervisors, economists and politicians are focusing our efforts on more competitive. The oligopoly of three companies that dominate the business with the ratings must be broken. So Angela Merkel has strongly for the creation of a European rating agency. Competition, so its logic animates the business.

Several scientific studies take this argument but sustainable in doubt. Thus Bo Becker of the Harvard Business School and Todd Milbourn of the Washington University in St. Louis the effects of greater competition among rating agencies first examined empirically and found: More competition leads to lower grades. "All evidence indicates that the quality of ratings is worse when the competition increases," was the conclusion of the work entitled "How Did Increased Competition Affect Credit Ratings?"

The work supports the findings of economists Heski Bar-Isaac (New York University) and Joel Shapiro (Oxford), in a theoretical study on the "Ratings quality over the Business Cycle" have come to similar conclusions. How can we explain this surprising result at first sight? can take a final view on the reasons cases Baker and Milbourn. The delivery of the data is not applicable. A conjecture, however, exclude the researchers is to find any evidence that could search for issuers of bonds by the increased competition, the rating agency, which was particularly well disposed towards them.

That more competition leads to poor grades, the economists explain, therefore, with some special features of the rating market: the agencies are paid not by the users of their work, the investors, but from the issuer of the securities. And they have a high interest in good ratings.

The most important incentive for Moody’s and Co., its principals still not talking after the mouth is, maintaining their reputation. A good reputation guarantee that investors will continue to rely on the judgments of the agencies – and the issuers were forced to entrust these companies further. The sharper but the competition between rating agencies is, the more uncertain would follow orders. Customers would rather point between agencies and switch back, say the researchers. This increases the temptation for the service, direct customers to talk to hear.

Becker Milbourn and focus their work on the rise of the rating agency Fitch into the 90s. The company has since established itself as the third force in the market for the valuation of corporate bonds. Came later in 1997 only one out of ten rating by Fitch, was the market share of the agency ten years later at around 30 percent. However, Fitch is not in all industries are equally represented. For banks, utilities and retail, the Agency has a larger market share than in the entertainment and transportation industries.

The researchers compared the quality of credit ratings in industries in which Fitch was strong and there was consequently enormous competitive with those in which the newcomer had hardly ever set foot on the ground. The quality and the conceptual meaning of the ratings were, the researchers according to several indicators – such as the percentage of good ratings. They found that the more competition there was in one segment, the greater the inflation of good grades. The share of credit ratings, which was near the top ratings of AAA "rose markedly – a sign that the agencies rather favor an expert opinion.

Lower information content, more defaults

fix A second indication of the Becker and Milbourn the lower quality of ratings, the reaction of financial markets. Normally there is a very close connection exists between the judgments of the agencies and the risk premiums that investors demand for these bonds.

The greater the competition among rating agencies in an industry was, the stronger this relationship broke up. Investors took the ratings less seriously. "This suggests that more competition reduces the information content of credit ratings," says the study. This observation also speaks against the fact that inflation is the high marks due to improved fundamentals have come.

Most clearly shows the lower quality if you compare the judgments of rating agencies with the actual credit losses. In industries with little competition between Moody’s, Standard & Poor’s and Fitch accounted for eight percent of all payment defaults on bonds of issuers that have a good credit rating (investment grade) possessed. In industries with high competition, it was 29 percent.