The Implementation Of Credit Rating Agencies

Subprime lending became prevalent in the early 2000’s when property values were sky-rocketing and many Americans thought they would fulfill their home ownership dreams, by obtaining loans they may not otherwise qualify for. A subprime loan is a loan offered to an individual who does not qualify for a loan at the prime rate due to their credit history. Subprime loans have higher interest rates because of the risk that the lender is taking. During the early 2000’s the housing market was great for homebuyers, since interest rates where low and property values

The beginning of the crisis is rooted in banks giving out subprime loans to people who would have not otherwise been given these loans. The banks assumed that these loans could be bundled and the numbers proved that they were safe investments, because enough people would pay their loans back.

These losses necessitated governmental action in the financial markets. Companies such as Lehman Brothers and Bear Stearns lost all of their stock’s value and were forced into bankruptcy. This risk spread throughout the American banks, forcing the American government to step in and buy all of the securitized, troubled assets from the balance sheets of

The enormous amount of unsecured consumer debt created by this speculation left the stock market essentially off-balance. Many investors, caught up in the race to make a killing, invested their life savings, mortgaged their homes, and cashed in

The beginning of the crisis is marked as the downfall of Bear Stearns Financial. The company, with a triple A rating, was sidelined with problems of lack of cash flow, and a piling up of unpaid debts on housing mortgages. Bear Stearns invested heavily in these mortgages, because they were lucrative so long as the loans were being paid off. Foreclosures did not begin to pile up until after the 2005-2006 years of mass investment in the housing boom had already seeped into every corner of the United States. The first feeling of a tremble in the market caused Bear Stearn's stock to plummet, and the

These brokers have neither the credit skills nor the interest to conduct proper payment due of potential homebuyers. Their interest is only in selling the houses as fast as they can. The MBS instruments allowed all financial institutions to transfer the risks to other investors. The dissociation of ownership of assets from risks encouraged poor credit assessment and was fundamental increasing the risks.

On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman 's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. The consequences for the world economy were extreme. Lehman’s ' fall contributed to a loss of confidence in other banks, a worldwide financial crisis and a deep recession in many countries. Lehman 's collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U.S. and internationally. Many questioned the U.S. government 's decision to let Lehman fail, as compared to its tacit support for Bear Stearns, which was acquired by JPMorgan Chase & Co. (JPM) in March 2008. Lehman 's bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15.

During the recent financial crisis, in the autumn of 2008, the Lehman Brothers bank collapsed. It was the biggest bankruptcy in history

There has been a debate for years on what caused the Financial Crisis in 2008 and if there was one main cause, or a series of unfortunate events that led to the crisis. The crisis began when the market was no longer funding many financial entities. The Federal Reserve then lowered the federal funds rate from 5.25% to almost zero percent in December 2008. The Federal Government realized that this was not enough and decided to bail out Bear Stearns, which inhibited JP Morgan Chase to buy Bear Stearns. Unfortunately Bear Stearns was not the only financial entity that needed saving, Lehman Brothers needed help as well. Lehman Brothers was twice the size of Bear Stearns and the government could not bail them out. Lehman Brothers declared bankruptcy on September 15, 2008. Lehman Brothers bankruptcy caused the market tensions to become disastrous. The Fed then had to bail out American International Group the day after Lehman Brothers failed (Poole, 2010). Some blame poor policy making and others blame the government. The main causes of the financial crisis are the deregulation of banks and bank corruption.

Lehman 's high degree of leverage - the ratio of total assets to shareholders equity - was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly susceptible to deteriorating market conditions. On March 17, 2008, following the near-collapse of the second-largest underwriter of mortgage-backed securities (Bear Stearns) - Lehman shares fell as much as 48% on concern it would be the next Wall Street firm to fail. Confidence in the company made a come-back to some extent in April, after raising $4 billion through an issue of preferred stock that was convertible into Lehman shares at a premium of 32% to its price at the time. However, the stock resumed its decline as hedge fund managers began questioning the valuation of Lehman 's mortgage portfolio.

On September 10, 2008, Lehman Brothers announced the lowest decline as the shares dropped to 45%. It left the market value at $5.4 billion after the Korea Development Bank rejected to make an investment deal that could rescue Lehman. The company would seek capital from other investors in order to recover their financial situation. These efforts faltered and the situation grew more severe, even after the US government had already saved the Bear Stearns and Fannie Mae and Freddie Mac. Though it is less likely that the US government will keep Lehman's bailout, there should be a resolution from the Federal Reserve System to bolster Lehman’s finance so as to prevent the US economic declination.

Originally when the first lender Bear Sterns became in trouble the reaction from Treasurer Secretary Henry Paulson was to let them fail and deal with the outcome on their own. After further review of the dealings Bear Stern had with several other financial intuitions, it soon became clear that if this happened several other lenders would soon follow in bankruptcy. Henry Paulson and the United States Federal Government decided that this was something they could not let happened and stepped in. The United States government stepped in and was able to work out a deal with JP Morgan to buy out Bear Sterns, hoping to stop the systemic risks in other lenders on Wall Street. Henry Paulson wanted to make sure it was know that this was not a decision that was to be taken lightly

In this essay, we are trying to look at the factors responsible for the global financial crisis in 2008-09 which started in US and later spread across the world. By now, a lot of studies have been done on the global financial crisis of 2008. We explain briefly the role of the financial engineering which leads to combination of various financial securities, the actual risk of which is not clearly assessed and hence leading to the financial crisis. There were also some serious lapses in regulation and failure of the rating agencies in assessing the risks assumed by the financial products which accentuated the crisis.

Credit rating agencies (CRAs) have been playing a significant role in financial markets around the world since the beginning of the twentieth century. The industry of credit rating originated when John Moody, a Wall Street analyst and the institutor of one of the biggest CRAs in present day, introduced a system of credit rating for railroad bonds by publishing “Moody’s Manual of Industrial and Miscellaneous Securities” in 1909. Until today, there are now approximately 150 CRAs operating around the world.

De Haan and Amtenbrink(2011) argued that there are flaws in the use of credit rating agencies judgement in regulation and accounting. The agencies have a substantial impact on the bonds and their interest. But when the bond is downgraded it is harmful. There will be herd behaviour among investors trying to liquidate investment. Additionally Mathis (2009) said that the construction of issuer pays is a critical problem which may result in conflict of interest. This will make the issuers to shop the ratings. They will go for the rating agency that provides the most favourable rating.