Let’s say that you want to lend a company some money, not from the goodness of your heart of course but to gain something out of it. You lend that money by buying bonds-pieces of paper with the amount lent, the runtime and the interest rate. They get the money; you get the paper. When the arranged time has passed, you get the money that you lent plus a little something on the top. But no risk no fun. If that company goes bankrupt, your money is lost forever. So before you lend your money and invest in a company what you really need to do is find out if it is securely afloat or going under. But how on earth are you going to do this?
Introducing Credit Rating Agencies
Digging through mountains of data, digging out old articles and talking to people that may or may not have any connection with that company’s financial situation isn’t the best way to go about it. Because analyzing financial papers isn’t particularly fun, why not go to a company that whole offers these kinds of services? These business experts analyze the bond issuer, and after running all the numbers, they give it a credit rating. Triple-A means your money is safe, while C and D pretty much mean that your money is gone. Rating agencies are considered as the foundation of finance. Without them, investors are basically blindfolded, and their investment’s success would be determined by sheer luck and chance.
Where the Problem Occurs
Being everyone is depending on rating agencies to predict whether a certain company’s financial situation will go up or down, rating agencies gained power. When everybody believes that a lower rate interest is an unprofitable investment, nobody wants to buy it. At least not with the low-interest rate, so the rate interest of that company goes up. This is what makes paying pack that money a lot harder for companies. So if a rating company “feels like it” it can make a smoothly running business go bankrupt within the blink of an eye. The same rule applies for countries. That’s why every time agency downgrades a country’s credit rating it becomes a major new story.
But credit rating isn’t as solid as people might think. This became painfully clear after the financial crisis of the 2000’s. It all revolved around shoddy mortgages that were bundled, repackaged and sold again. In this eyes of rating agencies, this repackaging was enough to transform junky mortgages into a really safe investment, which they weren’t. And because everyone trusted the rating agencies they believed led to being gold until it all blew apart and became transparent. This had a major impact on the economy, an impact from which many companies, as well as states, are having difficulties recovering from. This is exactly why it’s important to rely on our own business assessment of the situation, as it is the only way to have control over our actions.