Rating the Analysis in the Current Recession: A Review of Moody's and Standard and Poor's

By Dreibelbis, Steven; Breazeale, Jonathan | Academy of Banking Studies Journal, January-July 2012 | Go to article overview

Rating the Analysis in the Current Recession: A Review of Moody's and Standard and Poor's


Dreibelbis, Steven, Breazeale, Jonathan, Academy of Banking Studies Journal


INTRODUCTION

For financial markets to be truly efficient, information must be clear, consistent, and available. Most variations of the efficient market hypothesis assume that information is accurate and transparent. Credit reporting agencies, also referred to as debt rating agencies, primarily composed of Standard and Poor's, Moody's, and Fitch Ratings, are essential to the maintenance of efficient markets by assessing the quality of certain investments. When these ratings, which are relied upon by investors and governments alike, are erroneous, the entire economy suffers. The history and purpose of the credit reporting agencies and how these companies operate with limited accountability will provide insight into the responsibility the agencies share in the worst economic disaster since the Great Depression. While there were many organizations and

agencies to "blame" for the credit crash, the purpose of this paper is to provide a comprehensive historical context in which to view Moody's and Standard and Poor's recent role.

HISTORICAL BACKGROUND

The credit agencies' primary function is to determine the creditworthiness of the various issuers of securities. These agencies can trace their roots to the early nineteenth century during which the railroads were the first major industry of the United States and perhaps the world (Levich, Majnoni, & Reinhart, 2002). By 1832, the railroad industry began publication of The American Railroad Journal which was a highly specialized publication that reported on current events within the industry (Levich et al., 2002). Henry Varnum Poor became editor of the journal in 1849 and began focusing on investors as the target audience (Levich et al., 2002). During his tenure as editor from 1849-1862, Mr. Poor published information about the holdings of the railroads, and their assets, liabilities, and earnings (Levich et al., 2002). After the American Civil War, Henry Poor formed his own company and publication called the Manual of the Railroads of the United States (Levich et al., 2002). Poor only obtained and reported on factual information about companies which may be obtained on a company's annual report today. During the twentieth century, financial information about a company was difficult to acquire and very few understood the accounting and meaning of the reported data. It was not until 1916 that the Poor Company entered the bond rating business by analyzing various securities (History, 2006). The Poor Company began publishing its U.S. focused ninety-stock composite price index which was computed daily (History, 2006). This would become the S&P 500, a market value weighted index, which focused on the value of the five hundred most widely held companies in the U.S. economy (History, 2006). During the Great Depression, Poor's Publishing went bankrupt and was refinanced. Poor's Publishing eventually merged with Standard Statistics in 1941 (History, 2006). In 1966, The McGraw-Hill Companies, currently a dominant textbook publishing, magazine, and construction company, purchased Standard and Poor's (History, 2006).

John Moody also founded a company in 1900 that produced manuals detailing company information and statistics on stocks and bonds (Moody's History, n.d., para. 1). Moody fell victim to the 1907 stock market crash and was forced to cease operations (Moody's History, n.d., para. 2). Two years later, John Moody returned to the financial markets by offering investors an analysis of security values instead of a compilation of data (Moody's History, n.d., para. 3). During the early to mid twentieth century, analysis of companies' securities was expanded. In 1914, Moody's Investors Service was incorporated and expanded rating coverage to include municipal bonds (Moody's History, n.d., para 4).

From the first manuals ever published until the 1970s, Moody's and Standard & Poor's charged investors a fee for access to financial information--the only income received from their analysis (Moody's History, n. …

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