STARTING in 1909, a dense book from John Moody would thud on to subscribers' desks in America, following days or even weeks in the post. The annual railroad-bond ratings were out. America's fledgling debt markets moved accordingly.
Moody's business still thrives almost a century later. Credit ratings – assessments of the likelihood that an issuer will default on the interest or principal due on its bonds – now shoot through the market at internet speed and cover bond issues of all kinds. Whether a company has the highest possible AAA rating or a BBB- plays an important part in determining the rate at which it can borrow. In America only a bold or foolish company, municipality, state or even school district would try to issue debt without first getting a rating from Moody's, Standard & Poor's (S&P), its chief rival, or Fitch, a French-owned upstart that has become the world's third-biggest rating agency (see Figure C10.1).
The leading ratings firms have lucrative franchises and face only limited competition in a business that, thanks to the growth of global capital markets, has greatly expanded. These days, S&P, for example, rates $30 trillion of debt, representing nearly 750,000 securities issued by more than 40,000 borrowers. All three big raters are highly profitable, with Moody's enjoying the highest operating margin – of more than 50% of revenues.
Credit ratings have been embraced by financial markets because they mostly do what agencies ...