FINA 307, Leigh Roberts 23 April 2017 1

FINA 307 Ass 3, 2017: Ratings Bureaux by Leigh Roberts

Mimi-essay of about 1000 words, on Ratings Bureaux

Please upload your assignment, as a PDF file PLEASE, into Blackboard by the end of
week 8, = Fri 12 May 2017 (11.59 pm). In particular please insert page numbers, and word
count if easily available from your computer. Name and ID on top of first page please

Nature of the topic

Ratings Bureaux is a very broad topic, but vital for getting some sort of feel for the
GFC in particular; and more importantly for getting a feel for the general malaise afflicting
the financial sector overall.
The intention is to get you to look up google or similar search engine for articles to look
at; read or skim a few of these that appeal; and write down in a coherent fashion some of
your ideas therefrom. Rather than trying to cover all aspects of ratings bureaux, you are
better off to pick one or two aspects and discuss these.
Possible main themes for your mini-essay could include one or two of the following

1. great history (bearer bonds originally? story starts around US civil war in 1864?)

2. only 3 main ratings bureaux (Standard and Poors, Moodys, Fitch; also Bests for
insurance; but there are many others, quite small I think)

3. model of sales (of ratings) has changed in the last 50 (?) years to issuer of bond/security
pays RB, not the potential buyer of the security (as was previously the case).

(a) issuers of bonds/CDOs/MBSs in GFC shopped around to get best rating;

(b) issuers engineered CDOs/MBSs so that senior tranches were given AAA rating;
i. enhanced appeal of CDOs to conservative investors
(c) conflict of interest for RBs
(d) if they did not match another RBs rating, they would lose the business

4. Big 3 RBs do not just rely on publicly available information; small ones have to

5. approved RBs enshrined in legislation, including Dodd Frank

(a) unethical anyway?? Also this gave enormous advantage to big 3

FINA 307, Leigh Roberts 23 April 2017 2

6. technical: the models used by RBs were based on

(a) historical data
i. few defaults over great moderation 1990 - 2005
ii. so CDSs were cheap in GFC
A. so punters who bought CDOs protected themselves by also buying CDSs
B. but the CDSs defaulted in the crisis (eg AIG, Lehmann)
(b) Simplistic RB models assumed independence of defaults (like the Poisson as-
sumptions underlying the insurance claims in Ass 2)
i. but in catastrophes, everything is correlated
ii. one bond default can start a run of defaults
iii. one big bank in trouble in GFC, all banks get jittery
7. Also the RBs (secret) models predict occurrence of defaults, but not their seriousness
(frequency easily estimated from past, even if the past is not a reliable indicator of
the future; but severity pretty random, and quite ill-defined anyway)
References required please
References should be inserted at the end of the mini-essay, say at least 2 or 3 of them.
I am not too bothered about the precise format in which you give the references, reasons
for which include:
1. Most references for this assignment will be from the internet, and one does not neces-
sarily know the name of the author, or the date (perhaps just from a blog?). Trying
to write this sort of citation down and referencing it might not be easy: just do
something sensible (perhaps part of a URL if you are really stuck?). A reference in
the bibliography should normally be cited in the essay/assignment.
2. Aim to give me enough information so that I could find your references by myself,
working just from your bibliography.
3. I am not much interested in precise formatting: eg, using commmas or boldface; or
writing author names as E B Jones or Ebenezer Jones or Jones E B
My marking
Your assignment should cohere (i.e., it makes sense as I read it, with reasonable structure
and flow). See more detailed comments in the guidelines for essay assignment writing and
my marking, under course resources/course information on bbd.