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Smoothing the Way for Debt Markets

Firms' Influence Has Grown Along With World's Reliance on Bonds

By Alec Klein
Washington Post Staff Writer
Tuesday, November 23, 2004; Page A18

The credit-rating business was the creation of a young man who got his start at a Wall Street bank in 1890 as an errand boy for $20 a month.

Dreaming of becoming a millionaire, John Moody had an epiphany one morning while reading the newspaper. With so little known about a growing number of corporate securities, someone was bound to publish an industrial manual offering financial information to investors. "When it comes," he recalled thinking in his autobiography, "it will be a gold mine."

A 1909 portrait of John Moody hangs in the Museum of American Financial History in New York, a testament to the importance of the company he founded.

About This Series

Unchecked Power: The world's three big credit-rating companies have come to dominate an important sector of global finance without formal oversight. The rating system has proved vulnerable to subjective judgment, manipulation and conflicts of interest, people inside and outside the industry say.
Moody's Close Connections
When Interests Collide
Graphic: The Rating Game

Shaping the Wealth of Nations: As more countries rely on the bond markets to raise capital, they have been forced to accommodate the three top rating firms. The credit raters often have more sway over foreign fiscal policy than the U.S. government.
Transcript: Post Writer Alec Klein
Smoothing Way for Debt Markets
Graphic: Moody's Expansion

Flexing Business Muscle: Lack of oversight has left the rating companies free to set their own rules and practices, which some corporations say has led to abuses. The credit raters have rated companies against their wishes and ratcheted up their fees without negotiation.
New Choices for Consumers
Graphic: Raters' Big Misses

_____World Markets_____
Global Economies
International Stocks

In 1909, Moody started mining. He published a book about railroad securities, using letter grades to assess their risk. Investors looking for more certainty liked the idea, and the Moody business took off. So did Poor's Publishing Co., which began rating corporate debt in 1916, according to its successor company, Standard & Poor's. Standard Statistics Co. followed suit in 1922. Fitch entered the rating business in 1924.

In the ensuing decades, corporate America has increasingly turned to credit raters to smooth the way for its loans. As recently as the 1980s, companies did about half of their borrowing from banks. Now, the vast majority comes from the debt markets, which offer lower rates.

Over the past 30 years, the credit raters have also made significant inroads overseas, rating sovereign governments. In the 1970s, S&P rated only the United States and Canada; Moody's Investors Service added a third, Australia. None was a risk. That began to change when sovereign ratings took off in the 1980s and 1990s. By the year 2000, the major companies were rating about 100 nations each.

By most measures, the influence of the rating companies has continued to grow along with the size of the market for bonds and other debt, which is about $52 trillion worldwide. In the United States alone, about $21 trillion in debt was in the market in 2003 -- about 50 percent more than the value of all shares of stock being traded in the U.S. markets -- and almost none of that money could flow without a rating.

Today, as many as 150 credit rating agencies operate worldwide. But effectively, only two -- possibly three -- matter.

Wall Street confirms this fact when brokers buy or sell a bond for a client. When they call up the issue on the computer screen, the screen almost always has only two or three spots for credit ratings. Investors expect ratings from Moody's and S&P, each of which controls about 40 percent of the market. "You basically have to go to Moody's and S&P," said Dessa Bokides, a former Wall Street banker. "The market doesn't accept it if you don't go to both of them."

Third-ranked Fitch Ratings, which has about a 14 percent market share, sometimes is used as an alternative to one of the other majors.

"You're talking about an oligopoly," said Lawrence J. White, a former bank regulator and now economics professor at New York University's Leonard N. Stern School of Business. "Somebody who wants to buy wheat in the wheat market has a whole lot more choice than someone who wants to get a rating on a bond. There's three to choose from, and if you need more than one [rating], then you have to select two out of three, which in essence means you have one degree of freedom."

Staff researcher Meg Smith contributed to this report.

© 2004 The Washington Post Company