What Is Moody's?
Moody's Corporation is the holding company that owns both Moody's Investor Services, which rates fixed income debt securities, and Moody's Analytics, which provides software and research for economic analysis and risk management. Moody's assigns ratings on the basis of assessed risk and the borrower's ability to make interest payments, and its ratings are closely watched by many investors.
Investors worldwide pay close attention to the ratings that Moody's assigns to bonds, preferred stock, and government entities. Moody's ratings go from AAA, which is the highest grade for the top quality issuer with the lowest risk down to C, which is usually given to securities that are in default with little chance of the principal being repaid.
Moody's dates back to "Moody's Manual," which was first published in 1900; it provided general information and statistics about stocks and bonds. In 1909, "Moody's Analyses of Railroad Investments" added analytic information about debt instruments. Moody's Investor Services was established in 1914 and built on that foundation. It was bought by credit reporting company Dun & Bradstreet in 1962 but was spun off in 2000; it has been an independent company since.
In 1975, the U.S. Securities and Exchange Commission made Moody's a Nationally Recognized Statistical Rating Organization, along with Standard & Poor's and Fitch. Many institutions require a certain level of credit rating from an NRSRO entity in order to buy a given issue; the rating also impacts the capital requirements that the Securities and Exchange Commission applies to banks in the United States.
2008 Financial Crisis
Moody's, S&P, and Fitch have all been heavily criticized for their role in the financial market crisis of 2008. Much of the criticism centers around the AAA ratings that were given to mortgage-backed securities that in many cases were comprised of subprime loans. The ratings agencies' highly complex models failed to take into account the possibility of a broad nationwide decline in housing prices and how that would impact the performance of the bonds.
In 2007, as housing prices began a widespread decline, Moody's downgraded 83% of the mortgage securities that had been rated AAA just one year earlier. The prevalence of a system in which a bond's issuers pay the ratings company for their work has been blamed by some observers for inflated ratings. Moody's competitor S&P paid $1.5 billion to the Justice Department, 19 states, and the District of Columbia to resolve allegations that it knowingly misled investors.
Moody's was criticized by many Europeans for aggressive sovereign ratings downgrades during the crisis, at a time when the U.S. government rating remained AAA despite budgetary problems.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, which was passed in the aftermath of the 2008 crisis, established the Office of Credit Ratings within the SEC; the commission was also given broad supervisory powers over the three NRSROs. The OCR is required to review the performance of the agencies on an annual basis and can fine or de-register them if necessary.