Rating Agencies and their role during the financial crisis

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Seminar paper from the year 2011 in the subject Economics - Finance, grade: 1.3, Berlin School of Economics and Law, language: English, abstract: After the Asian crisis during the 1990s and the startling insolvencies of Enron and Parmalat, the recent financial crisis is one the most important trigger to raise doubt concerning the proper work of rating agencies. They are criticized because of their various conflicts of interest and obvious deficits in practicing their rating methods. The rating agencies should be jointly responsible for the emergence of the so-called bubble markets during the last couple of years. Because of these bubbles and their boom and burst effect, private as well as institutional investors lost enormous sums of assets and single countries were thrown into financial turmoil. Because of these facts, the discontent concerning the rating agencies grew. People took additional notice of their market power, which they only obtained because of their influence on the global capital flows and the use of ratings to regulate the financial markets. To particularize the issues, it is helpful to bring up the year 2007, when the delayed payments among the subprime loans became more frequent. This was due to the slower increase of the housing prices and the rising short-termed interest. Consequently, the rating agencies depreciated a lot of these structured financial products, many of which had received the highest seal of quality before (AAA). Those actions both led to a massive loss of confidence on the investors' side and a remarkable decline of liquidity. The former market of securitization products no longer existed. Influenced by this development and because they were considerable involved in this securitization business, a lot of banks also got into this downstream. In the first part of this term paper I will present some general facts about the rating agencies including their history of origins. Afterwards I will mention the process of rating and the problems, which led to the misconduct during the crisis. This will also include a discussion concerning the IOSCO Code of Conduct and the deduced implications concerning the malfunction of the rating agencies. Last but not least I will give a conclusion and suggest some essential aspects which should be implemented from the rating agencies.