Inflated Bond Ratings

Inflated bond ratings helped spur the financial crisis. They’re back.

That was the glaring headline in the Wall Street Journal online on Aug. 7, 2019, when the Journal published my months-long investigation into inflated credit ratings.

The ubiquitous letter grades are a key component of most bond sales since they tell investors the relative riskiness of the bonds they’re buying. A bond rated triple-A is not expected to lose any money while anything rated below the triple-B category is considered non-investment grade and far more susceptible to losses. Many investors follow mandates based on ratings that delineate the types of bonds they can hold, making ratings a crucial part of the financial system.

If credit ratings sound familiar, it’s probably because you’ve heard that they were a contributor to the 2008 financial crisis. Inflated credit ratings issued in the run-up to the 2008 financial crisis cost saddled investors with more than $400 billion of losses on securities that they thought were safe but which turned out to be worthless, according to one study.

As we reported, there’s a long-acknowledged flaw behind ratings inflation that Washington didn’t fix: Entities that issue bonds also pay for their ratings. That gives issuers an incentive to hire the most lenient rating firm because interest payments are lower on higher-rated bonds. Increased competition among ratings firms after the 2008 financial crisis let issuers more easily shop around for the best outcome.

To gauge the impact of increased competition among ratings firms, my colleague Gunjan and I analyzed about 30,000 ratings within a $3 trillion database of structured securities issued between 2008 and 2019 (read our methodology here). The data, compiled by deal-tracker, allowed a direct comparison of grades issued by six firms: majors S&P, Moody’s and Fitch, and three smaller firms that challenged them since the financial crisis, DBRS, Kroll Bond Rating Agency and Morningstar.

Here’s what we found:

The Journal’s analysis suggests a key regulatory remedy to improve rating quality—promoting competition—has backfired. The challengers tended to rate bonds higher than the major firms. Across most structured-finance segments, DBRS, Kroll and Morningstar were more likely to give higher grades than Moody’s, S&P and Fitch on the same bonds. Sometimes one firm called a security junk and another gave a triple-A rating deeming it supersafe.

Inflated Bond Ratings Helped Spur the Financial Crisis. They’re Back. WSJ, 8/7/2019.

You can read the full story here, or see this TV spot I did on CNBC for a quick overview of our key findings.

After our August story, we followed-up with additional stories on ratings inflation in other segments of the bond markets, as well as other issues related to credit rating integrity. Here are the major stories in the series:


There have been other developments since we started reporting on credit ratings last August.

Besides downgrades of some of the bonds we profiled, an SEC advisory committee of bond investors began examining alternative business models for ratings firms. Here’s my write-up of the panel’s Nov. 4 hearing in New York.

The SEC has also been getting pressure from lawmakers to take action on the issue. In early February, I wrote about a bipartisan letter from four Senators asking the SEC why the agency failed to revamp the credit-ratings industry’s conflicted business model in the wake of the financial crisis.

Later in February, I traveled to Las Vegas for the Structured Finance Association’s annual conference, where a senior SEC executive gave a speech to the securitization industry about the agency’s credit ratings oversight. Jessica Kane, who runs the SEC’s Office of Credit Ratings, said the agency is rethinking its post-crisis effort to improve the quality of bond ratings. It was a tacit acknowledgment that the decade-old program I profiled in October has failed to meet its objective. Here’s my write-up of Ms. Kane’s speech, which put credit ratings firmly on Washington’s financial regulatory agenda.

The SFA’s conference was probably one of the last events in Las Vegas before city – and much of the country – hit pause due to the coronavirus pandemic. That’s created upheaval ion Wall Street, including bond markets, where the economic impact of the virus has created a massive repricing of risks. I’ve been busy covering the ensuing bond downgrades and risks facing structured products such as collateralized loan obligations, among other things.

I’ll continue to keep an eye on this. As always, if you have any newstips or suggestions for stories, please don’t hesitate to contact me.