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User:Mysidae/Credit rating agency history

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History of credit rating agencies

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Early history

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Following the financial crisis of 1847, agencies were established in the United States to rate the ability of merchants to pay their debts, which they published in ratings guides.[1] These mercantile rating agencies are now seen as the precursors of the credit rating agencies.[2]

Credit rating agencies originated in the U.S. in the early 1900s, when ratings began to be applied to securities, specifically those related to the railroad bond market.[1] In the U.S., the construction of extensive railroad systems had led to the development of corporate bond issues to finance them, and therefore a bond market several times larger than in other countries. The bond markets in the Netherlands and Britain had been established longer but tended to be small, and revolved around sovereign governments trusted to honor their debts.[3] Companies were founded to provide investors with financial information on the growing railroad industry, including Henry Varnum Poor's publishing company, which produced a publication compiling financial data about the railroad and canal industries.[4] Following the 1907 financial crisis demand rose for such independent market information, in particular for independent analyses of bond creditworthiness.[5] In 1909, financial analyst John Moody issued a publication focused solely on railroad bonds.[6][7][5] His ratings became the first to be published widely, in an accessible format[8][5][3] and his company was the first to charge subscription fees to investors.[7]

In 1913, the ratings publication by Moody's underwent two significant changes: it expanded its focus to include industrial firms and utilities, and began to use a letter-rating system. For the first time public securities were rated using a system borrowed from the mercantile credit rating agencies, using letters to indicate their creditworthiness.[9] In the next few years, antecedents of the "Big Three" credit rating agencies were established. Poor's Publishing Company began issuing ratings in 1916, Standard Statistics Company in 1922,[5] and the Fitch Publishing Company in 1924.[6]

Growth of bond market

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The relationship between the U.S. bond market and rating agencies developed further in the 1930s. As the market grew beyond that of traditional investment banking institutions, new investors again called for increased transparency, leading to the passage of new, mandatory disclosure laws for issuers, and the creation of the Securities and Exchange Commission (SEC).[3] In 1936, regulation was introduced to prohibit banks from investing in bonds determined by "recognized rating manuals" to be "speculative investment securities" ("junk bonds", in modern terminology). Banks were permitted only to hold "investment grade" bonds, following the judgment of Fitch, Moody's, Poor's and Standard. State insurance regulators approved similar requirements in the following decades.[6]

In the late 1960s and 1970s, ratings were extended to commercial paper and bank deposits, and the major agencies began to charge bond issuers as well as investors.[5] Reasons for this change included a growing free rider problem related to the increasing availability of inexpensive photocopy machines,[10] and the increased complexity of the financial markets.[11] Rating agencies also grew in size as the number of issuers accessing the debt markets grew exponentially, both in the United States and abroad, making the credit rating business significantly more profitable.[12]

The end of the Bretton Woods system in 1971 led to the liberalization of financial regulations, and the global expansion of capital markets in the 1970s and 1980s.[5] In 1975, the SEC changed its minimum capital requirements for broker-dealers, using bond ratings as a measurement. Ten credit rating agencies (later six, due to consolidation) were identified by the SEC as "nationally recognized statistical ratings organizations" (NRSROs) for broker-dealers to use in meeting these requirements.[6][13] It was at this point that SEC rules began explicitly referencing credit ratings.[14]

During this period, the growth of the capital markets led more useful credit ratings globally; ratings were increasingly used in most developed countries' financial markets. In addition, there was an increase in the number of ratings agencies outside of the U.S. Along with the four largest U.S. raters, one other U.S., one British, two Canadian, and three Japanese firms are listed among the world's "most influential" rating agencies by the Financial Times in its publication Credit Ratings International.[1]

The ratings systems used by the agencies also underwent change during the period from the early 1970s to early 1980s. In 1973, Fitch began to use plus and minus symbols added to its existing letter-rating system, creating more levels of gradation to allow greater detail in distinguishing between issuers. The following year, Standard and Poor's added plus and minus symbols to their ratings, and Moody's began using them in 1982.[1]

1980s to present

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The 1980s and beyond were a time of significant expansion for the global capital market[5] and the number of bonds rated by the Big Three agencies grew substantially as well.[7] Ratings agencies also began to apply their ratings to counterparty risks, performance risk of mortgage servicers and price volatility of mutual funds and mortgage-back securities.[1] Following this expansion, in the 2000s, the credit agencies experienced increased profits.[15] The 1990s and 2000s were also a time of increased scrutiny, as ratings agencies were subject to lawsuits by unhappy issuers[16] and investigation by the U.S. Department of Justice,[17] as well as criticism following the collapse of Enron,[5] the U.S. subprime mortgage crisis and subsequent late-2000s financial crisis.[18][19]

References

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  1. ^ a b c d e Cantor, Richard; Packer, Frank (Summer/Fall 1994). "The credit rating industry". Federal Reserve Bank of New York Quarterly Review. Federal Reserve Bank of New York. p. 1-26. ISSN 0147-6580. {{cite news}}: Check date values in: |date= (help)
  2. ^ Langohr, Herwig M.; Patricia T., Langohr (2009). The rating agencies and their credit ratings. Wiley, John & Sons, Incorporated. ISBN 9780470018002.
  3. ^ a b c Richard Sylla (1–2 March 2000). A Historical Primer on the Business of Credit Ratings (PDF). The Role of Credit Reporting Systems in the International Economy. Washington, D.C.: The World Bank. Retrieved 21 September 2013.{{cite conference}}: CS1 maint: date format (link)
  4. ^ Karp, Gregory (14 August 2011). "Ratings game: Power of S&P, other top credit agencies, grew from government action". Chicago Tribune. Retrieved 21 September 2013.
  5. ^ a b c d e f g h Sinclair, Timothy J. (2005). The New Masters of Capital: American Bond Rating Agencies and the Politics of Creditworthiness. Ithaca, New York: Cornell University Press. ISBN 978-0801474910. Retrieved 21 September 2013.
  6. ^ a b c d White, Lawrence J. (Spring 2010). "The Credit Rating Agencies". Journal of Economic Perspectives. 24 (2). American Economic Association: 211–226. doi:10.1257 (inactive 2023-08-02). Retrieved 22 September 2013. {{cite journal}}: Check |doi= value (help)CS1 maint: DOI inactive as of August 2023 (link)
  7. ^ a b c Yasuyuki, Fuchita (2006). Financial Gatekeepers: Can They Protect Investors?. Washington, D.C.: Brookings Institution Press. ISBN 978-0815729815. Retrieved 21 September 2013. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  8. ^ Richard S. Wilson (1987). Corporate Senior Securities: Analysis and Evaluation of Bonds, Convertibles, and Preferreds. Chicago: Probus.
  9. ^ "Moody's History: A Century of Market Leadership". moody's.com. Retrieved 17 September 2013.
  10. ^ White, Ben (31 January 2002). "Do Rating Agencies Make the Grade?; Enron Case Revives Some Old Issues". The Washington Post.
  11. ^ White, Lawrence J. (24 January 2009). "Agency Problems—And Their Solution". The American. American Enterprise Institute. Retrieved 21 September 2013.
  12. ^ Clarke, Thomas (2009). European corporate governance: readings and perspectives. Taylor & Francis. p. 15. ISBN 9780415405331. Retrieved 21 September 2013.
  13. ^ "Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organization" (PDF). sec.gov. Securities and Exchange Commission. 2 February 2007. Retrieved 19 September 2013.
  14. ^ Christopher Cox (26 September 2007). "The Role and Impact of Credit Rating Agencies on the Subprime Credit Markets". sec.gov. Securities and Exchange Commission. Retrieved 20 September 2013.
  15. ^ Younglai, Rachelle; daCosta, Ana (2 August 2011). "Insight: When ratings agencies judge the world". Retrieved 20 September 2013.
  16. ^ Utley, Michael (12 June 1996). "Orange County widens lawsuit to include S&P, Morgan Stanley". The Bond Buyer.
  17. ^ "Watching the Watchers: Justice Department Launches Probe of Moody's Ratings". Tulsa World. 28 March 1996.
  18. ^ "Ratings in structured finance: what went wrong and what can be done to address shortcomings?". CGFS Papers. 32. Committee on the Global Financial System. July 2008.
  19. ^ Gallu, Joshua; Faux, Zeke (27 September 2011). "SEC's Notice to S&P May Signal Enforcement Cases Against Raters". Bloomberg Businessweek. Retrieved 19 September 2013.
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