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The Credit Rating Crisis

In: NBER Macroeconomics Annual 2009, Volume 24

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  • Efraim Benmelech
  • Jennifer Dlugosz

Abstract

Since June 2007, the creditworthiness of structured finance products has deteriorated rapidly. The number of downgrades in November 2007 alone exceeded 2,000 and many downgrades were severe, with 500 tranches downgraded more than 10 notches. Massive downgrades continued in 2008. More than 11,000 of the downgrades affected securities that were rated AAA. This paper studies the credit rating crisis of 2007-2008 and in particular describes the collapse of the credit ratings of ABS CDOs. Using data on ABS CDOs we provide suggestive evidence that ratings shopping may have played a role in the current crisis. We find that tranches rated solely by one agency, and by S&P in particular, were more likely to be downgraded by January 2008. Further, tranches rated solely by one agency are more likely to suffer more severe downgrades.

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This chapter was published in:

  • Daron Acemoglu & Kenneth Rogoff & Michael Woodford, 2010. "NBER Macroeconomics Annual 2009, Volume 24," NBER Books, National Bureau of Economic Research, Inc, number acem09-1, July.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 11794.

    Handle: RePEc:nbr:nberch:11794

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    1. Benmelech, Efraim & Dlugosz, Jennifer, 2009. "The alchemy of CDO credit ratings," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(5), pages 617-634, July.
    2. Skreta, Vasiliki & Veldkamp, Laura, 2009. "Ratings shopping and asset complexity: A theory of ratings inflation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(5), pages 678-695, July.
    3. Damiano, Ettore & Li, Hao & Suen, Wing, 2006. "Credible Ratings," Microeconomics.ca working papers, Vancouver School of Economics damiano-06-01-17-01-56-45, Vancouver School of Economics, revised 17 Jan 2006.
    4. Ingo Fender & John Kiff, 2004. "CDO rating methodology: Some thoughts on model risk and its implications," BIS Working Papers 163, Bank for International Settlements.
    5. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, Elsevier, vol. 13(2), pages 187-221, June.
    6. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2010. "The credit ratings game," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1221, Department of Economics and Business, Universitat Pompeu Fabra.
    7. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    8. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    9. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports, Federal Reserve Bank of New York 318, Federal Reserve Bank of New York.
    10. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    11. Adam Ashcraft & Paul Goldsmith-Pinkham & James Vickery, 2010. "MBS ratings and the mortgage credit boom," Staff Reports, Federal Reserve Bank of New York 449, Federal Reserve Bank of New York.
    12. Efraim Benmelech & Nittai K. Bergman, 2008. "Collateral Pricing," NBER Working Papers 13874, National Bureau of Economic Research, Inc.
    13. Peter DeMarzo & Darrell Duffie, 1999. "A Liquidity-Based Model of Security Design," Econometrica, Econometric Society, Econometric Society, vol. 67(1), pages 65-100, January.
    14. Kashyap, Anil K. & Rajan, Raghuram G. & Stein, Jeremy C., 2008. "Rethinking capital regulation," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 431-471.
    15. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
    16. Bo Becker & Todd Milbourn, 2008. "Reputation and competition: evidence from the credit rating industry," Harvard Business School Working Papers, Harvard Business School 09-051, Harvard Business School, revised Sep 2010.
    17. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, American Finance Association, vol. 45(1), pages 49-71, March.
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