Credit rating agencies seek redemption

A year after the global credit crisis erupted, credit rating agencies still face a long process of restoring reputations and profits that took a century to build.

In 1909, a young entrepreneur named John Moody published a manual of railroad securities and assigned a letter grade to measure the risk of each bond, a major innovation at the time.

The idea was a hit, and Moody and his fledgling company established a name in the market for accurately assessing and measuring risk.

Moody's system became a force in the financial world, challenged later by rivals Poor's Publishing Co. in 1919 and Standard Statistics Co. in 1922, which devised slightly different grading scales. John Knowles Fitch entered the scene in 1924. The modern ratings business was born - and boomed.

Today the reputations of Moody's Investors Service, McGraw-Hill's Standard & Poor's and Fimalac's Fitch Ratings are in question because they expanded too fast into rating "structured finance debt," including instruments such as collateralised debt obligations (CDOs).

Those complex debt instruments helped fuel huge profits for banks and investors during the US housing boom between 2001 and 2007, but then saw their value implode over the past year as US home prices dropped, costing banks and investors billions of dollars in losses.

Since August last year, Moody's Corp's shares have plummeted 32 per cent and McGraw-Hill shares lost 27 per cent of their value, leading to the departure of top executives, including the head of Moody's structured finance unit last month. Fimalac shares have fallen 26 per cent.

And billions of dollars worth of pristine "AAA" letter grades have since fallen to junk bond status of "CCC" or lower, and come to symbolise something else entirely than investment grade.

"The Scarlet Letter syndrome is what we're concerned about, first and foremost," Deborah Cunningham, chief investment officer at Federated Investors, said recently, referring to an American novel about a woman, named Hester Prynne, who was forced to wear a scarlet letter "A," a public badge of shame for committing the sin of adultery.