Many sorts of organizations are required to only invest in AAA rated instruments. Consequently, the market for AAA is about 10 times that of AA. The CDO issuers bullied or bribed the rating agencies to whitewash everything with AAA ratings.

Look, Tom. Let’s be honest, they make mistakes, but by and large, their ratings have worked for years. Investment grade ratings fail much less than junk. And AAA, least of all. They get criticized for being late to change ratings, and they get criticized for changing ratings too much, as a rating change itself can cause fundamentals to change. Damned if you do, damned if you dont’. I certainly don’t like the fact they hide behind the fact that their ratings are ‘just opinions’ but clearly waaaay too many investors use a bond rating as the ONLY analytical source., and then they are not willing to admit to not doing their bit, their own homework. And most investors I know still value alot of their work and can set aside the structured products debacle. That’s a very separate business; nearly everyone (they included) got that wrong.

This is probably right as far as corporate and government securities go, but the argument most people make about the rating agencies and the real estate bubble is because it was much harder, even impossible, to independently asses the risk characteristics of the various mortgage-back securities, investors were far more dependent on the rating agencies than in other cases. So the general view seems to be that they played an independent role in the housing boom and bust, regardless of a regulation.

Good discussion in this paper.

Any and all actions can be seen through a political lens if one wishes, but it seems to me that there are legitimate reasons for a downgrade. Furthermore, ratings are largely irrelevant except for regulatory purposes. Any respectable bond manager does his or her own research and ratings follow market yields, not the other way around. Put it in another way, the market almost always has already “downgraded” a bond by demanding higher yields far in advance of any actual downgrade by a ratings agency. GE bonds traded at below AAA ratings for months prior to any downgrade, and Lehman’s bonds were already trading at junk levels when S&P finally decided to downgrade. Even more to the point, the CDO and derivative securities that were rated AAA always had to offer higher yields than “regular” AAA corporate debt, indicating that they were never AAA to begin with.

The mess was caused, in part, due to the way regulations give special treatment to AAA rated securities regardless of how the market perceives them. The power of the ratings agencies come from regulations, they have only marginal influence on market yields and usually follow the yields. Large impacts come from contractual obligations that would put bonds into technical default or subject them to renegotiation should they ever be rated below a certain point. Other than that, the ratings are mostly irrelevant for investors and bond managers. Regulations empower the agencies, it’s all about the regulations.

http://johnquiggin.com/index.php/archives/2009/02/27/standard-poor/

Here are some tentative suggestions for an alternative, along the lines suggested by Paul

http://johnquiggin.com/index.php/archives/2008/03/08/after-the-ratings-agencies/