Rating Agencies and the Fallout of the 2007–2008 Financial Crisis

by Petra Lieven (Author)
©2016 Thesis 298 Pages


This book examines rating agencies role in the recent financial crisis and proposed reforms. It summarizes the key causes that have led to the crisis, analyzes points of criticism and accusations leveled at rating agencies, and discusses proposals towards regulatory reform. The author takes rating agencies position regarding these accusations and proposals into account. In contrast to other studies focusing only on US and EU regulatory issues, this study also considers whether responses from other countries could deliver a feasible path in adopting new regulations. The author examines in a cross-country qualitative manner stakeholder perceptions with respect to rating agencies. Based on empirical findings the study discusses how perceived or revealed shortcomings can be solved.

Table Of Contents

  • Cover
  • Title
  • Copyright
  • About the author
  • About the book
  • This eBook can be cited
  • Acknowledgements
  • Abstract
  • Table of Contents
  • Abbreviations
  • List of Figures and Tables
  • Introduction
  • 1. What Caused the Economic and Financial Crisis 2007–2008?
  • 1.1 Background
  • 1.2 The Financial Market Turmoil 2007–2008
  • 1.2.1 MBS Corrections and the Securitization Business
  • 1.2.2 Rating Agencies
  • 1.2.3 Global Markets Contagion
  • 1.3 Conclusion
  • 2. The Crisis of 2007–2008
  • 2.1 On the Role of Rating Agencies
  • 2.2 Rating Agencies’ Role in Structured Finance
  • 2.3 Main Points of Criticism Leveled at Rating Agencies
  • 2.3.1 Conflicts of Interest in Rating Agencies’ Business Model
  • 2.3.2 Lack of Competition
  • 2.3.3 Liability of Rating Agencies
  • 2.3.4 Lack of Transparency in the Rating Process
  • 2.3.5 Deficiencies in the Rating Method and in the Rating Process
  • 2.3.6 Quasi-Regulatory Role of Rating Agencies
  • 2.4 Conclusion
  • 3. The Rating Agencies’ Defense – A Critical Review
  • 3.1 The Role of Rating Agencies and their Rating in the Capital Markets
  • 3.2 Managing Conflicts of Interest
  • 3.2.1 Rating Agencies Business Model
  • 3.2.2 Individual Conflicts of Interest
  • 3.2.3 Rating Shopping
  • 3.3 Competition Amongst Rating Agencies
  • 3.4 Liability
  • 3.5 Trancperency in the Rating Process
  • 3.6 Perceived Weakness in the Rating Process
  • 3.7 Regulatory Role of Rating Agencies
  • 3.8 Conclusions
  • 4. The Rating Process
  • 4.1 Rating Symbols, Definitions and the “SF” Modifier
  • 4.2 Creation of Structured Finance Instruments
  • 4.2.1 How Rating Agencies Conduct the Rating Process for Structured Finance Instruments
  • 4.2.2 Request for Rating
  • 4.2.3 Pre-Analysis
  • 4.2.4 Proceeding of the Rating Process
  • 4.2.5 The Committee Process and Communication of Decision
  • 4.2.6 Assigning the Final Rating
  • 4.3 Areas of Analysis
  • 4.3.1 Analyzing the Financial Structure of the Transaction
  • 4.3.2 Initial Evaluation
  • 4.3.3 Cash Flow Analysis
  • 4.3.4 Synthetic Transactions
  • 4.3.5 Assessing Operational and Administrative Risks
  • 4.3.6 Analysis of Counterparty Risks
  • 4.3.7 Legal and Transaction Document Risks in Structured Finance Transactions
  • 4.4 Rating Action Commentary and Supporting Guidelines
  • 4.5 The Role and Function of Credit-Quality Monitoring
  • 4.6 Conclusion
  • 5. Rating Agencies and Price Determination in Financial Markets
  • 5.1 Price Theory and Prices
  • 5.2 Distinguishing Between Price and Value
  • 5.2.1 Evaluation of Value and Price for Financial Products
  • 5.2.2 Deriving Prices from Values
  • 5.3 Markets, Credit Markets, and Prices
  • 5.3.1 Price Determination in Credit Markets
  • 5.4 Rating Agencies and their Role in the Determination of Prices
  • 5.4.1 Abstraction and Reduction of Reality
  • 5.4.2 Calculative Tools and Judgment Devices
  • 5.5 Conclusion
  • 6. Regulators, Regulations, and Price Determination in Financial Markets
  • 6.1 Regulation of Financial Markets
  • 6.1.1 History of Regulations in Financial Markets
  • 6.1.2 Objectives of Financial Market Regulation
  • 6.1.3 How Regulators and Regulations Regulate Financial Markets
  • 6.1.4 Regulation, De-Regulation, Liberalization, and their Impact on Globalization
  • 6.2 Regulatory Impact on Price Determination in Financial Markets
  • 6.2.1 Prices and Regulation
  • 6.2.2 Effects of Regulatory Rules on Insider Trading and Price Formation in Financial Markets
  • 6.3 Regulatory Issues Related to Rating Agencies
  • 6.3.1 A Regulatory Paradigm for Rating Agencies
  • 6.3.2 Private Securities Litigation Reform Act of 1995
  • 6.3.3 The Sarbanes-Oxley Act of 2002
  • 6.3.4 Credit Rating Agency Reform Act of 2006
  • 6.3.5 Basel I to II framework
  • 6.3.6 The Rating Agencies Paradox and the Consequences of Under Regulation
  • 6.3.7 The de Larosière Report and the FSA Turner Review
  • 6.4 A Regulatory Future for Rating Agencies
  • 6.5 Conclusion
  • 7. Responses to Rating Agencies Shortcomings
  • 7.1 The European Position
  • 7.1.1 Regulation and Reform of Rating Agencies after the 2007–2008 Crisis
  • 7.1.2 The “Basel” Perspective
  • 7.1.3 Current Regulatory Efforts (2013)
  • 7.1.4 The European Rating Agency Case
  • 7.2 The Chinese Position (and an Emergent Russian Ally)
  • 7.3 The Indian Position
  • 7.4 The Canadian Position
  • 7.5 The Australian Position
  • 7.6 The Japanese Position
  • 7.7 Rating Agencies and the Future of Regulatory Oversight
  • 7.8 Conclusion
  • 8. Empirical Research: Design and Methodology
  • 8.1 Purpose and Research Approach
  • 8.2 Research Approach
  • 8.3 Research Strategy
  • 8.4 Selected Research Method
  • 8.5 Methodology Interviews
  • 8.6 Data Collection
  • 8.7 Quality Criteria
  • 8.8 Questionnaire Development
  • 9. Empirical Research: Results
  • 9.1 Topic 1: Helpfulnes of Credit Ratingss and the Absence of Binding Guidelines
  • 9.2 Topic 2: Intelligibility of Rating Agencies’ Terminology and Methodology – Alternative Ways to Assess Credit Risk
  • 9.3 Topic 3: Removal of References to Credit Ratings
  • 9.4 Topic 4: Liability of Rating Agencies
  • 9.5 Topic 5: Alternatives to Rating Agencies in General and their Embedding in a Governmental Setting
  • 9.6 Summary
  • 10. Discussion, Further Research, Limitations, and Conclusion
  • 10.1 Discussion
  • 10.2 Further Research
  • 10.3 Limitations
  • Conclusion
  • References

← XIV | XV →



List of Figures and Tables

← XX | 1 →


The financial crisis of high indebtedness has affected financial institutions and investors around the globe (Moshirian, 2010). The roots of this crisis can be traced backed to the collapse of the US subprime market, and failure of deregulation policies for the financial sector enacted by political and regulatory authorities’ failures with regard to the deregulation of the financial sector (Gotham, 2009). This market sector has experienced rapid development in recent years, and the new financial instruments that have emerged have reached previously unimaginable “levels of sophistication” (Shahzad, 2013, p. 1). The major rating agencies (Moody’s, Standard & Poor’s, and Fitch) act as financial gatekeepers in the development of the market for structured finance instruments (Partnoy, 2006), and the rapid growth of the market for such sophisticated products would not have been possible without the involvement of these rating agencies (Darbellay, 2013). Investments in such structured finance products were at the heart of the recent crisis (Chambers et al., 2011), with rating agencies being blamed for having failed the market by providing overly positive assessments regarding the quality of these structured finance products, and being too late in adjusting their ratings to worsening market conditions (Sève, 2009). As a consequence, rating agencies became a target of ongoing international criticism directed not only against errors of judgment, but also for operating in a biased manner due to their business model in an oligopolistic market structure (Fons, 2010). Indeed, regulatory authorities, governments, bond issuers, and investors across the globe lost their blind trust in the ratings supplied by these rating agencies, and thus believe that changes must be made in order to restore market confidence (SIFMA, 2013). The initiation of regulatory responses has therefore been an international process, but there is “no consensus on a single set of reforms” (Katz, Salinas, and Stephanou, 2009, p. 5). Measures announced or undertaken fall within the objectives of managing conflicts of interest, improving the quality of rating methodologies, and increasing transparency and measurements to replace self-regulation (Katz, Salinas, and Stephanou, 2009). However, as Utzig (2010, p. 3) argues, although “the scope of the selected regulatory approach is extremely narrow” and undoubtedly has the potential “to improve corporate governance of CRAs and prevent conflicts of interests,” these approaches can unfortunately do nothing to address “repeated calls for greater competition or for CRAs to be made liable for their ratings.” ← 1 | 2 →

This research focuses on explaining and discussing the criticisms that have been leveled at rating agencies during the fallout of the 2007–2008 financial crisis. In addition, it investigates the role rating agencies played in causing the recent crisis, and provides an understanding of the reforms to regulatory frameworks that affect the functioning of the rating industry that have been proposed, implemented, or are currently underway. Accordingly, the research addresses two specific questions. First, how can perceived or revealed shortcomings be resolved? Second, what proposals or solutions should be advanced or implemented to achieve the desired goals?

To tackle these questions and to obtain an overview of regulatory measures, the following research provides a brief synopsis of the factors that led to the crisis, and then analyzes the criticism to which rating agencies have been subjected, along with the concrete problems that have become increasingly evident in recent years. In so doing, the position of the rating agencies is also taken into account. Furthermore, the role played by rating agencies and regulatory authorities in the price determination process of financial markets and US regulatory issues relating to rating agencies are outlined. Thereafter, responses to rating agencies’ shortcomings from Europe, Asian Pacific countries, India, and Canada are analyzed. This research applies the applicable theoretical literature on rating agencies’ perceived shortcomings, their role in financial markets, and the effects of regulatory measurements in order to identify the relevant aspects required to answer the questions raised. The perspectives drawn from the literature reviewed are examined and discussed to provide a framework for an empirical investigation. In addition, the research assesses the views of financial market participants after the global financial meltdown of 2007–2008, and explores, empirically, the impact of the crisis on market participants’ perceptions of the quality of ratings provided by rating agencies, together with their liabilities. The objective of this empirical evaluation is to identify a range of possible remedies to existing problems.


ISBN (Hardcover)
Publication date
2016 (October)
Frankfurt am Main, Bern, Bruxelles, New York, Oxford, Wien, Warszawa, 2016. 298 pp., 7 b/w tables

Biographical notes

Petra Lieven (Author)

Petra Lieven holds a Master of Business Administration degree from the University of Wales (Cardiff) and received her doctoral degree from the Cyprus International University (Nicosia). She is head of accounting/controlling at a German venture capital company.


Title: Rating Agencies and the Fallout of the 2007–2008 Financial Crisis