Persuasive Paper

The issue of the effectiveness of the credit ratings system is a controversial one. The credit ratings system effectiveness has been questioned recently due to several mishaps that have led to important consequences for the economy. The mishaps from the ratings agencies range from making mistakes in their calculations to assigning ratings to securities that led to severe consequences to the U.S.economy. I believe that the credit ratings system is no longer effective because the rating agencies are no longer providing objective assessments of the corporations and the securities issued by these companies.
The credit rating companies were created to help investors decide where to invest their money; the ratings assigned to securities by these companies gives the investors an objectiveassessment of the credit worthiness of companies and countries. The rating assigned to countries is called a sovereign credit rating and measures the country’s ability to provide a secure investment environment (Heakal, 2009). There are different rating companies over the world but there are only a few that stand out. The largest credit rating companies are Fitch, Moody’s and Standard & Poor’s(S&P). These companies shared almost 75% of the market in 2007 (Henderson, 2009).
Recently, rating companies have been under a lot of scrutiny and have been questioned on the effectiveness of their ratings. The question of whether credit ratings worked started with the subprime meltdown, where rating companies assigned high ratings to mortgage-backed securities and made them appear less risky thanthey actually were. In April 2011, the Senate’s permanent subcommittee on investigations said that “S&P, Moody’s and Fitch helped inflate the mortgage bubble by engaging in a “race to the bottom” to assign top ratings to risky securities” (Faux & Shenn, 2011). This situation proves that the rating companies were not effective in recognizing the risk that the mortgage-backed securities represent tothe investors and poses the question of whether there should be reforms in the ratings system.
Another example of the loss of effectiveness of credit ratings occurred in the past month when Standard & Poor’s decided to downgrade the United States treasury bonds from the rating AAA to AA. This situation stirred a lot of controversy, especially since the consequences of granting a rating of AA tothe treasury bonds would lead to bad consequences for the economy of the United States, leading to higher credit rates as well as less confidence in the economic stability of the country. The response from the U.S. government was to point that there was an error in the projections of S&P of $2 trillion, which S&P recognized but did not back down from their decision. Although there was muchspeculation about the effects of the rating downgrade, the effects were not as expected; the treasury bonds remained stable and while lower rates meant more risk and therefore higher yields, treasury bonds yields had plunged since the downgrade. This market behavior is not consistent with S&P downgrade, implying that investors are not taking into account the downgrade and do not agree with the predictionsof S&P (Faux & Shenn, 2011).
Moreover, S&P, according to Bloomberg, has assigned a AAA rating to more than $36 billion of U.S. securitized debt this year. This situation tells investors that S&P believes the U.S. government bonds are riskier than the securitized bonds backed by houses, malls and even auto dealer loans. Investors do not particularly agree with S&P, because they do not understandhow a treasury bond that is backed by the US government can have a lower rating than a securitized bond. The ratings are inconsistent given the fact that S&P believes that securitized bonds will survive if the U.S. government defaults which is not likely; the sovereign rating is one of the first things that investors take into account to invest in other countries and if the U.S. government...