Question

Just before the collapse of the subprime mortgage market in $2007$, the most important credit-rating agencies rated mortgage-backed securities with Aaa and AAA ratings. Explain how it was possible that a few months into 2008, the same securities had the lowest possible ratings. Should we always trust credit-rating agencies?

Short answer

The rating agencies' incorrect ratings contributed to the subprime mortgage market's collapse in $2007$. Rating agencies cannot always be trusted upon. These agencies may fail to rate because they may grade individuals more favorably in order to profit from those who are rated.

Step-by-step solution

Introduction

Debt is a financial instrument that a company releases to raise funds and then pays interest to the investors. The interest rate on a loan might be either fixed or variable.

To determine

Trust in credit rating agencies and the same securities with the lowest possible rating

Explanation

The subprime market is one that deals with lending to those who do not have a solid credit history. Lending money to people or organisations with a questionable credit history is dangerous. Individuals in this situation can borrow money from the subprime market.

The rating agencies' incorrect ratings contributed to the subprime mortgage market's collapse in $2007$. Rating agencies cannot always be relied upon. These agencies may fail to rate because they may grade individuals more favorably in order to profit from those who are rated.