Credit-rating agencies (CRA) had a huge part in starting the economic crisis in 2008. CRA gave companies like Lehman brothers and AIG at least A ratings a couple of day's before collapse. And not to mention all the collateralized debt obligations (CDO) they gave positive ratings that were clearly no safe investments at all. When the different CRA had to come to congress for their part in the economic crisis they said: "The ratings are our opinion, they don't have to be true" I believe that investors give money to CRA to make sure they give positive ratings to their CDO's. But if they do this why would investors trust the CRA's in their ratings?
You know the saying: He who controls the information... similar the Orwell quote, "He who controls the past controls the future."
Credit ratings can be somewhat useful if you understand what they mean. Credit rating is a static measure of the quality of credit of an entity. It is NOT a forecast of the future credit quality of that entity. For example, while a firm may have a AAA rating today, the rating agency does not guarantee this rating in future periods or under different macroeconomic scenarios. It can however be useful as an input to a more dynamic model that can forecast credit quality at a later date. What the financial institutions who know what they are doing do, is use a credit spread model. Usually they will compute the options adjusted spread by simulating hundreds of thousands of interest rate & prepayment paths (where the interest rate is a random variable described by a probability distribution) and for each path they calculate the cash flow, discount it, and then take the average. A large options adjusted spread means greater credit risk, a lower options adjusted spread means less risk.
