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Moody Corporation Credit Rating Process Essay

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Updated: Jun 26th, 2020


Investor confidence is a pillar of the financial system. Investor confidence in the financial industry is nurtured by the bond of trust that exists among the members of the financial system, who include regulatory bodies, net savers, and net borrowers. Therefore, a healthy financial system can only exist where participants within that industry have enough confidence in the institutions that exist within that financial industry. It can be said that the relationship of participants of the financial system can only be successful if information is properly acquired and objectively analyzed to guide the decision making process (Lawrence 454).

Credit rating companies and security analysts have a duty of objectively and honestly analyzing and rating securities in a way that reflects the true situation that will enable investors make independent and objective investment decisions. As a result once a credit rating agency carelessly carries out its rating activities, it may paint a wrong picture for both investors and issuers. Any rating mistakes in the credit rating process by analysts and credit agencies such as Moody, S&P and Fitch is highly risky especially when dealing with millions or possibly billions of dollars may be detrimental to investors and other stakeholders and therefore the eventual decrease in investor confidence.

What Moody did wrong

Moody’s Business Expansion and the Increased Pressure from the Top Management that directed other business executives to increase their revenues and market Moody could be partly blamed as the genesis of the whole problem. Credit ratings done by companies like Moody were especially vital for investors in mortgage based securities and since investors had no way to access such information they relied on the judgment of the existing credit agencies such as Moody.

On the other hand, companies such as Moody who were the aristocrats of the ratings business pressured their employees to achieve revenue targets and therefore business executives ended up poorly rating the securities. The downgrading of security based mortgages on the other hand ended up miss-judging the actual risk and therefore misleading both investors and those people who took out mortgages that were later pooled by other intermediary institutions.

The role of Moody’s corporation and other credit rating agencies that ended up wrongly and in accurately rating several thousands of bonds which had been pooled into bundles of subprime mortgages that belonged to individuals who had poor credit ratings was the biggest mistakes that Moody did. Having existed for almost a century, many participants of the financial systems fully trusted the analysis and recommendations of Moody Corporation, and therefore did not use extensive credit rating techniques to accurately come up with more objective information. In addition, Moody Corporation was absorbed in a stiff competition with other credit rating information agencies and ended up doing a shoddy credit rating job, which ended up costing the investors billions.

Shareholders who were helped/hurt by Moody Corporations ratings

Consequently, the overall American financial system was negatively affected by the credit rating information that Moody provided, many investors and lenders of mortgages either lost their money or homes. Furthermore, investment banks such as Lehman Brothers, Bear Stearns, and Merrill Lynch ended up being closed down or being sold off and neither commercial banks such as Washington Mutual, Country wide and Wachovia were not spared. The element of confidence and trust in the American financial system was significantly affected by a large magnitude which included both individuals and financial institutions and therefore found themselves operating on reduced budgets. It therefore became hard for the financial institutions to lend out funds to businesses and even businesses.

While individuals might have enjoyed acquiring houses at fairly good rates in the short run soon after, the mortgage prices sharply fell and previous credit ratings were downgraded and this was the point that it was realized that the American subprime mortgage market was going to lose over $ 90 million as a result, loans were reset and individuals who had taken out mortgages found it extremely difficult to keep up with their current mortgage payments. It therefore became expensive for these individuals to pay their mortgages and vacated their homes. On the other hand, government regulations over financial system participants came under criticism and therefore the government was blamed for letting organizations within operate without a proper legal framework

Moody’s conflict of interest

Credit rating agencies had become highly competitive and more business oriented and therefore disregarding the interest of the American investor making it easy for major banks and other investment institutions play agencies of one another. Furthermore this investment bodies such as banks searched for rating agencies with the lowest standards and therefore ignoring investor interests. Moody’s also had a conflicting interest between maintaining its market share and delivering high quality ratings because the kind of freedom those institutions such as investment and financial banks in America enjoyed making it possible for them to opt for credit rating agencies that would favorable rate their investment instruments.

And therefore in order to overcome situations of conflict of interest regulations, calling for full disclosure should be formulated and fully implemented. This can be achieved by the help of the government and a wholesale change of the leadership that run America’s credit rating industries. Therefore, the security exchange commission should tighten the grip and ensure that the issuer-pays model is critically re-examined to get rid of any loopholes which may give rise to incidences conflict of interest.

Sharing of responsibility for the financial downfall

Credit ratings agencies like Moody are not the only institutions that are to blame for the financial downfall. Many other institutions and participants of the financial system played a role in contributing to the failure of the financial system. The government for instance, applied poor regulation practices that allowed a degree of freedom that made it easy for financial institutions to miss-behave. The lifting of the Glass-Steagall Act paved way for indiscipline within the financial system because now unlike before, commercial banks would participate in investment banking activities, for these actions the policy makers bear the largest part of blame. On the other hand, home buyers could be blamed for not being totally honest by giving un-reliable information to financial institutions.

This is especially in some cases where American citizens who merely earned close to $50,000 a year accepted to take loans amounting to $ 500,000 it is therefore unrealistic and irresponsible for individuals who have low incomes which cannot sustain making periodical loan payments to accept such huge loans. On the other hand, mortgage lenders who used unsuitable techniques did not empower individuals to make independent informed decisions before taking out loans. Therefore many consumers of mortgages ended up making highly un-informed decisions that later ended up pushing them into financial bankruptcy and debt. It is not therefore the mistake of credit rating institutions such as Moody but rather a mistake of almost every participant of the financial system whose actions led to the financial downfall (Lawrence 454).

Prevention of future recurrence

It is highly important that America learns from the mistakes of the financial system and use these lessons to prevent any future re-occurrences of such magnitude from happening again. It is the responsibility of managers, the government, the general public, credit rating organizations and financial institutions to ensure that the financial system remains strong and healthy. The government and the legislature should be at the fore-front of setting full proof regulation that will protect the interest of American investors; furthermore competition between financial system participants should be regulated by legislation that will discourage unhealthy competition that may compromise the interests of the investors.

Furthermore, regulatory agencies should make regulations that will force financial institutions to fully disclose relevant information to borrowers of financial instruments such as mortgages that will enable them enter into financial decisions with prior full knowledge. Managers of financial institutions should operate with policies and practices that are highly ethical that take care of investor interests at institutional interests at the same time. The structure of credit rating industries should be transparent on order to prevent any chances of conflict of interest that may compromise the financial freedom and comfort of investors.

Works Cited

Lawrence, Anne. Presentation at the 2009 annual meeting of the North American Case Research Association. 2009. Print.

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