Credit Rating Failure In Sub-prime Crisis And Its Reason

Credit ratings provide individual and institutional investors with information that assists them. in determining whether issuers of debt obligations and fixed-income securities will be able to meet their revenue requirements with respect to those securities.At the early time of credit rating history, they only rate obligation debts and fixed-income securities. Along with development of financial market, globalization, and the creation of derivatives, credit rating market developed itself, and financial productions involved in credit rating increased a lots. Geographically, the "Big Three" expend their service to global market. They almost involved in most part of credit rating issues in international financial market. And the securities rated by credit rating agency (referred as CRA) are no more constrained to bonds and obligation debts, derivatives become a very important part in their service. Influence of credit rating was enhanced since 1970s. With enforcement of NRSROs by SEC, credit rating has become a very important part in portfolio management for institution investor. Governments rely much more on rating conclusion than ever before.In the course of sub-prime crisis, it is the securitization productions that are responsible for spreading the risk and recession to world economy. Investors get frustrated due to CRA failing to forecast the underlying risks in securitization productions. The reasons for CRA failure in predicting risk was discussed in this paper, focusing on the drawbacks of risk estimating model and the factors of functional inefficient market Then, several improvement suggestions for administration was provided based on some analysis.This issue is divided into 6 chapters.In Chapter 1, background of the study (Sub-prime Crisis), serious results brought by the crisis and the importance of this subject was demostrated. The booming in real estate market stimulated securitization market. With the help of globalization, the whole world was involved. After the Federal Reserve raised interest rate, lots of defaults lead to bad debts and losses in banks balance sheets. Finally, the failure of CRA during crisis was discussed and a main struction of this issue was provided.Chapter 2. The history of credit rating and its development nowadays are introduced, including the relationship between credit rating and the development of financial market, creation of derivatives, and globalization of financial market, and the reform of administration.Chapter 3. Securitization productions, including MBS,ABS,CDO,CDS, and credit enforcement are discussed, maily focusing on the risk characters of these production, especially pre-payment risk and credit risk.Chapter 4. The credit rating models, and thier drawbacks in practice are discussed in this chapter. The main difficulties in rating practice includ (1) cash flow prediction,(2) quantity models estimateing risks,(3) the forecast validity of history data. Models in this paper include Traditional Binomial model, Monte Carlo simulation,risk model for MBS.Chapter 5. The non-theory reasons for failure of CRAs are discussed, which includes problems of transparence of this market, monopoly market which causes inefficiency, conflict of interest, fair dealing.Chapter 6. Suggestions improving market efficience are provided in this chapter. These suggestions involve enforcement of administration in management to avoid conflict of interest; bringing down barriers in market by reforming NRSROs; establishing rating effective eveluation system.