Remember those Lehman bonds that caused the Reserve money market fund to break the buck? How about all of those states that have struggled to balance their budgets? And let's not forget those mortgages (millions of them) that have fallen into foreclosure, dragging down the special investment vehicles that were created through securitization and marketed as safe, conservative investments. The commonality between all of these disappointments is that bond rating services, including industry giants Moody's Investors Service, Standard and Poor's and Fitch Ratings, certified them as solid, creditworthy investments. Now, the ratings services are being called on the carpet for their misdeeds by legislators and customers alike. This could be bad news for the big bond raters. (Despite investor distrust, rating agencies can be helpful. Just be sure you use these ratings as a starting point. Find out more in Bond Rating Agencies: Can You Trust Them?)

Rating the Raters
At the one end of the spectrum, Congress is looking into allegations that Moody's intentionally issued misleading ratings. The investigation is being spurred on by an ex-credit analyst and the ex head of Moody's compliance team. The analyst, Eric Kolchinsky has come forward with specific and damaging allegations that accuse Moody's of issuing high ratings from complicated debt securities when the firm was in the process of downgrading the underlying investments. The ex compliance chief claims that Moody's provides ratings on tens of thousands of municipal bonds that it doesn't monitor.

The Securities and Exchange Commission (SEC) is also taking a look at the situation. The SEC has proposed greater disclosure of the firm's ratings practices and hope to encourage additional ratings agencies to enter the business.

Crash Backlash
Scrutiny from legislators isn't the only trouble brewing for the rating agencies. Backlash from the credit market crash has insurance regulators looking to find a better way to vet bonds. The insurance industry relies heavily on the bond raters and holds some $3 trillion worth of bonds the agencies have rated. These bonds generate the revenue that will be used to fund payouts for a variety of insurance policies. Unfortunately, some of the ratings on those bonds have been less than accurate, resulting in billions of dollars worth of losses for investors and forcing insurance companies to ante up $2 billion in 2008 to prove to industry regulators that they could still fund the policies they have issued in the aftermath of the losses they took on their bonds.

Fighting Back
The companies aren't happy about the situation. The National Association of Insurance Commissioners (NAIC) is now considering the use of other sources of research to vet bonds in its members' portfolios. When their biggest customers are unhappy, the ratings agencies should be worried. (Don't want to be a passive investor? Discover how investment clubs allow you to take control of your portfolio, in Get Active, Join a Club!)

In an ideal world, the downstream impact of all of all this attention should be better ratings and greater safety for investors. In reality, the situation is likely to just get more confusing and more expensive as a ratings system that has been in place for decades undergoes a shakeup and yet another scandal takes its place in the record book.

Related Articles
  1. Professionals

    Holding Out for Capital Gains Could Be a Mistake

    Holding stocks for the sole purpose of avoiding short-term capital gains taxes may be a mistake, especially if all the signs say get out.
  2. Credit & Loans

    Co-signing a Loan? Make Sure You Know The Risks

    Contractually, co-signers are just as responsible for the loan as the person actually borrowing the money. Be careful not to put yourself at risk.
  3. Investing

    Why High Yield Still Has A Role To Play

    An asset class of this bull market has been high yield debt, as many searching for income in a low-rate world have turned to these higher-yielding bonds.
  4. Economics

    Is The EU Holding Germany Back?

    As Germany agrees to initiate bailout talks with Greece once again, could all of the EU's economic turmoil result in Germany being better off alone?
  5. Economics

    The Biggest Items Obama Is Still Missing From His Mandate

    Learn how the biggest items missing from Obama's mandate include various forms of tax reform and closing the Guantanamo Bay prison in Cuba.
  6. Investing Basics

    Explaining Bond Ratings

    A bond rating is a grade given to a bond to indicate its creditworthiness.
  7. Economics

    A Comparison Between a Default and a Collapse

    Is the Greek default similar to the Lehman Brothers collapse?
  8. Investing Basics

    Who Is The Next Greece?

    Several EU countries are on the potential candidate list, but some municipalities in the U.S. look far more like Greece. Could they be the “next Greece”?
  9. Bonds & Fixed Income

    Dodd-Frank Creates a Liquidity Crunch for Bonds

    While each individual institution is undoubtedly safer due to capital constraints imposed by Dodd-Frank, this makes for a more illiquid market overall. The lack of liquidity will be especially ...
  10. Economics

    Game Theory And The Greece Bank Crisis

    How can game theory help us understand how the Greece bank crisis will play out? As things come to a head, Greece and the Europeans are trying to hold out.
  1. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  2. Regional Asset Liquidation Agreement ...

    An agreement between an asset manager and the Federal Deposit ...
  3. The New Deal

    A series of domestic programs designed to help the United States ...
  4. Accelerated Resolution Program ...

    A program designed to reduce the time and cost of resolving failed ...
  5. Prime Credit

    A credit score that falls into the range that is one step down ...
  6. Super-Prime Credit

    Consumers with super-prime credit are considered to have excellent ...
  1. How can I use the funds from operations to total debt ratio to assess risk?

    The funds from operations (FFO) to total debt ratio is used in fundamental analysis to determine a company's financial risk. ... Read Full Answer >>
  2. How stable are municipal bonds?

    Stability is relative in the municipal bond market. Municipal bonds tend to be safer than many other types of investments, ... Read Full Answer >>
  3. Do negative externalities affect financial markets?

    In economics, a negative externality happens when a decision maker does not pay all the costs for his actions. Economists ... Read Full Answer >>
  4. Where can I find information about corporate bond issues?

    Information about new and existing corporate bond issues is published regularly in financial newspapers, such as The Wall ... Read Full Answer >>
  5. Why are high yield bonds typically lower rated bonds?

    The term "high-yield bond" is a bit of a misnomer. It is not the case that high-yield bonds tend to be lower-rated; instead, ... Read Full Answer >>
  6. What is the difference between disposable and discretionary income?

    According to the Bureau of Economic Analysis, or BEA, disposable income is the amount of money an individual takes home after ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!