Chapter 7: Growth of the structured finance segment
The role of the leading CRAs in structured finance ratings has given rise to significant concern in modern financial markets. In the run-up to the subprime mortgage crisis, CRAs attributed inflated credit ratings to mortgage-related securities that ended up performing very poorly. In the aftermath of the resulting rating scandals, lawmakers reformed the rating industry by means of a financial regulatory overhaul. The rating of structured finance products has contributed to a major change in the rating business over the last four decades. If the structured finance segment has enhanced the profitability of CRAs, credit ratings have played an equally crucial role in the extraordinary expansion of structured products. Indeed, the key to the successful launch of novel instruments was their assessment by a supposedly independent third party. From an issuers’ perspective, the leading CRAs appeared to be the ideal entities to provide this service. Moreover, from the 1970s to the 2000s regulators increasingly used ratings in their financial market regulations. Investors were, in turn, willing to buy securitized assets that received high ratings. In addition, courts considered ratings to be mere opinions protected by the First Amendment of the US Constitution. CRAs were exempted from liability even when their ratings proved to be inaccurate. Accordingly, CRAs benefited from a privileged position in the financial markets. Issuers took advantage of hiring CRAs in order to rate mortgage-related securities. They were able to convince CRAs to give high ratings to complex financial instruments in exchange for a fee.
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