The North American Securities Administrators Association is warning investors to “be wary of bond ratings” because inflated ratings, which were a key factor in the 2008 financial crisis, remain a concern today.
Investors “should look beyond” a credit rating “when considering investing in a specific bond of bond fund portfolio,” according to the NASAA advisory.
“Ratings agencies are being paid by the companies issuing the debt, so they have a big incentive to give favorable ratings to the company or underwriters will continue to come back,” notes the NASAA advisory. “Because of these and other shortcomings, ratings should not be the only factor investors rely on when assessing the risk of a particular bond investment.”
The payment model for ratings agencies has not changed despite the role that the agencies played during the financial crisis and the requirement in the Dodd-Frank Act the followed for the SEC to recommend an alternative business model for those agencies whose ratings could be used by companies for regulatory purposes.
According to the Financial Crisis Inquiry Commission, the three leading ratings agencies, Moody’s, S&P and Fitch, were found to be “key enablers of the financial meltdown … The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval … Their ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms.”