Why did the rating agencies do such a poor job in rating CDO’s?

Question

Had they more accurately assessed the risks of the CDO’s, instead of awarding them AAA ratings, would it be fair to say that investors around the world wouldn’t have been duped into buying these bad debts?

Or was part of the problem a lack of prudency on the part of the investors? To put it frank, have these investors been idiots?

Answer 1

The best arguement that you can make for the rating agencies is that they were stupid and did not know what they were reviewing.  The worst case is that they were paid for the transaction getting done, and were thereby influenced by higher ratings that got the deal sold.  Investors have to take some of the blame definately.  They have relied on the rating agencies for too long.  tba

Answer 2

I think the priciple of conflcit of interest might come into play in the answer to this ?

Answer 3

CDO's are very complex securities. Essentially the collatoral backing for a CDO can come from hundreds of places. To an extent their was a bit defrauding going on, as rating agencies have always, let's say, nudged their analysts to rate certain friendlies in a particular manner. None-the-less a lot of it came from a colossal misjudgment of the state of the housing market. Most of all since a lot of the collateral was insured; no one ever really expected the insurance companies to become strained. As for the investors, they may have been too reliant with ratings agencies. Pretty much, everyone's to blame on this one.

Answer 4

The credit agencies were paid by the people issuing CDO's a perfect "Conflict of Interest"

Tremendous pressure on the credit agencies to rate them high so the issuer of the CDO could sell it for the maximum profit in the market.

Answer 5

A good question without a real good answer.  Investors have virtually no way of knowing the credit worthness of many types of investment products and rely on the credit rating agencies almost exclusively, obviously with misplaced trust. There have been cases in the past also where AAA debt has gone into default, but we tend to forget these very soon after the fact.  Washington Public Power comes to mind.  AAA rated and the investors lost every cent.  

It is not just the CDO's that were mis-rated.  There are also seemingly billions of other debt that because of insurance  was mis-rated.  It appears that that insurance might possibly be nothing more than smoke and mirrors.  

And then there is the U S government debt also AAA rated.  How many companies would get even a junk rating if they had run a deficit for the last 6 years?  And where their interest expense was 10% of their revenue?  It would be more but hey they get to adjust the interest rate they pay downward.  ha ha ha.  Heck, even Ford's interest expense is only 5% of revenue and their debt IS rated as junk.