Credit rating agencies and the 2008 financial crisis: AAA ratings that failed

What do credit rating agencies do, and why do investors rely on them?

A credit rating agency grades the likelihood that a borrower or a security will repay. The scale runs from AAA, the safest, down to junk grades. Investors who cannot study every bond use the grade as a shortcut, and many funds set their holdings by grade. The grade therefore shapes who buys a security and at what price.

Before 2008 the agencies also graded structured products, whose payments depend on pools of loans. Grading a pool is harder than grading a company, since it needs a view of thousands of borrowers and of how they move together. The task was more complex than the shortcut implied.

Who paid the credit rating agencies, and why did that matter in 2008?

Under the issuer-pays model, agencies charge the issuer of a security a fee for the rating. Wikipedia reports that Moody’s, Fitch and S&P adopted the model in the early 1970s, and that it created a conflict of interest with accurate ratings for investors. An issuer unhappy with a grade could take its business elsewhere.

The EQOS Asia study names the same conflict in its integrity score of 0.08, listing agencies paid by issuers among the removed safeguards (EQOS Asia 2008 back-test, 2026). The conflict does not prove that any grade was dishonest. It explains why the incentives pointed one way.

How many AAA ratings did the agencies give to mortgage securities?

Wikipedia reports that Moody’s rated nearly 45,000 mortgage-related securities triple-A between 2000 and 2007, and that only 6 private-sector US companies held that top rating. Agencies rated roughly 70% to 80% of CDO tranches triple-A, and the study records 80% of tranches rated AAA (EQOS Asia 2008 back-test, 2026).

A top grade used to be rare and now covered a large share of new products. Supply of AAA paper rose faster than the supply of safe underlying loans. Structure made up the difference, by layering pools so that the top layer looked protected from the first losses.

How far did the AAA ratings fall in the 2008 financial crisis?

Of the mortgage-backed securities that Moody’s rated triple-A in 2006, 73%, worth over $800 billion, were downgraded to junk 2 years later, according to Wikipedia. The same survey reports that by the end of 2008, 80% of triple-A-rated CDOs by value had been downgraded to junk.

A fall from AAA to junk in 2 years ranks as a failure of the grade itself, since a AAA grade claims a very low chance of loss. Holders who had treated the grade as a safe harbour faced losses that their risk rules had called close to impossible.

Why were the credit ratings of mortgage securities so wrong?

3 causes stand out. The models assumed that defaults in a pool would stay fairly independent, yet falling home prices pushed defaults up everywhere at once. Data from a short, rising market gave little warning of a fall. And the structure allowed low-rated layers to become high-rated bonds, a pattern Wikipedia’s CDO article calls ratings arbitrage.

The result was a precise-looking grade built on a hidden assumption. A grade can be useful and still be wrong when the assumption fails, which is why a user of ratings benefits from asking what the grade assumes about the borrowers and about the housing market.

What changed for credit rating agencies after the 2008 crisis?

The Credit Rating Agency Reform Act of 2006 created a voluntary registration system and gave the SEC broader oversight authority, according to Wikipedia. The study notes that the act existed but had little force before the crisis. Dodd-Frank, passed in 2010, then required agencies to disclose how their ratings have performed over time.

It also subjected ratings to the same standards of liability and oversight as auditors and analysts, in Wikipedia’s account, and removed statutory references to ratings. The market structure changed little: the 3 largest agencies held about 97% of the business after the crisis, down only 1 point from 98%.

What did the inquiry say about credit rating agencies and the 2008 crash?

The Financial Crisis Inquiry Commission called the rating agencies’ failures "essential cogs in the wheel of financial destruction", as Wikipedia quotes it, and described the 3 largest agencies as key players in the process of mortgage securitisation. The strong language reflects how many investors relied on the grades.

A fair reading separates 2 points. The agencies made the wrong call on a large scale, and the whole chain of lenders, arrangers and buyers used the grade as a licence to hold risk. The study lists the conflict among several lost safeguards, none of which works alone.

Which 4 checks help you read a credit rating today?

Ask who pays for the rating, what the grade assumes about the borrowers, how the rater’s past grades performed, and whether the product is a pool whose parts move together. A rating that passes all 4 gives more confidence than a grade alone. This page is general information, not investment advice.

The EQOS Asia Λ simulator scores a system on 9 dimensions, including integrity, in 10 minutes. The method page explains how that score is built, and the result frames risk in a way a letter grade does not.

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About the author

Stéphane Jambu

President, EQOS Forecast Asia

Stéphane Jambu leads EQOS Forecast Asia and works as a consultant in e-commerce, search visibility, and AI. LinkedIn profile