Some people love them, some hate them, but no one would dispute that ratings agencies play an important role in financial markets today. Their influence is clearly evident, particularly with the recent GM and Ford revaluations.
When asked the basic question "What is a rating agency?" the names Moody's, S&P, and Fitch quickly come to mind as entities in the business of rating the investment quality of bonds. But Timothy Sinclair, a professor of international political economy at the University of Warwick, goes much further. He reviews in exhaustive detail who the ratings agencies are, where they came from, how they are regulated and operate in different countries, and how their role has shifted and been strengthened as the financial markets evolve.
One of the reasons for the increasing importance of ratings agencies is what the author calls the "disintermediation of the investment process." In the past, if your business needed money you probably went to a bank, and the rate the bank set for your loan was based on an evaluation of your creditworthiness. This has all changed. Increasingly such funding is provided via some stock or debt offering. And this is where the power of the ratings agencies has increased, since they provide an evaluation mechanism for the debt issued. Another big change cited is that ratings agencies have had to develop new ratings scales and skills in response to the advent of derivatives and structured financings. In addition, with the increased acceptability of the high-yield market, they've had to broaden the classes of debt securities they rate. The globalization of finance has also spread the use of these ratings and therefore the influence of these agencies. The tremendous growth in the demand for this type of information is illustrated by the fact that in the 1960s, S&P employed 3.5 full-time analysts: It has hundreds on staff today.
Agency ratings are not always on target. A whole chapter of the book is dedicated to examples of "blown calls," cases where ratings agencies didn't detect the trouble brewing for a company until it was too late. But despite these lapses and various accusations that the agencies are too monopolistic, Sinclair is strongly supportive of the necessity of what they do. He sees them as providing an important service to the financial community by offering a standardized means of assessment with which the debt markets can work.
There is no perfect science to arriving at ratings, and the book details the political and social factors at play in influencing these decisions. Beyond the financial markets, the book also examines the broader role these agencies play in business. Writes Sinclair, "The Ratings Agencies are promoters of an American-derived, synchronic mental framework. The most significant effect of ratings agencies is not, therefore, their view of budget deficits or some other specific policy, but their influence on how issuers assess problems in general."—Ann Cullen