Moody's History: The Evolution of Modern Credit Ratings
The modern financial landscape relies heavily on the ability to assess risk. At the center of this system is Moody's, a pioneer in the field of credit ratings. From its origins as a specialized publishing house to its role as a global financial powerhouse, the history of Moody's mirrors the growth and volatility of the global capital markets.
Founding and the Birth of Bond Ratings
The story begins with John Moody, the inventor of modern bond credit ratings. In 1900, he established John Moody & Company and published the Moody's Manual of Industrial and Miscellaneous Securities. This publication provided critical statistics on stocks and bonds across various sectors, including government agencies, manufacturing, mining, utilities, and food companies. The manual was an immediate success, selling out its first print run within two months and gaining national recognition by 1903.
Despite this success, the Panic of 1907 caused market shifts and a capital shortage that forced Moody to sell his business. However, he returned in 1909 with the Moody's Analyses Publishing Company, focusing on railroad bonds through a publication titled Analysis of Railroad Investments.
While Moody credited early efforts in Berlin and Vienna for the concept of bond ratings, he was the first to publish them widely in an accessible format and the first to charge investors subscription fees. By 1913, he expanded his focus to industrial firms and utilities, introducing a letter-rating system borrowed from mercantile credit-reporting firms. In 1914, the company was incorporated as Moody's Investors Service.
This innovation paved the way for other agencies, leading to the formation of the "Big Three" credit rating agencies: Poor's (1916), Standard Statistics Company (1922), and the Fitch Publishing Company (1924). By 1924, Moody's was rating nearly the entire U.S. bond market, including state and local government bonds which it began covering in 1919.
[ไม่มีภาพประกอบ]The Mid-Century Shift and Regulatory Influence
During the 1930s, the U.S. bond market expanded beyond traditional investment banking, prompting a demand for greater transparency. This led to the creation of the Securities and Exchange Commission (SEC) and new mandatory disclosure laws for issuers.
A pivotal change occurred in 1936 when new laws prohibited banks from investing in "speculative investment securities"—known today as junk bonds—as defined by recognized rating manuals. Banks were restricted to holding investment grade bonds, relying on the judgments of Moody's, Standard, Poor's, and Fitch. State insurance regulators eventually adopted similar requirements.
In 1962, Moody's Investors Service was acquired by Dun & Bradstreet, a credit reporting firm. Although owned by Dun & Bradstreet, Moody's continued to operate largely as an independent entity.
Global Expansion and the Issuer-Pay Model
The 1970s brought significant changes to the business model. As financial markets grew more complex and photocopy machines made information easier to share (creating a "free rider" problem), Moody's began charging bond issuers for ratings in 1970, in addition to charging investors. By 2005, Moody's estimated that 90% of its revenue came from these issuer fees.
The collapse of the Bretton Woods system in 1971 triggered the liberalization of financial regulations and the global expansion of capital markets. In 1975, the SEC designated Moody's and several other agencies as Nationally Recognized Statistical Rating Organizations (NRSROs), which broker-dealers used to meet minimum capital requirements.
Moody's aggressively expanded its global footprint, opening offices in:
- Japan (1985)
- United Kingdom (1986)
- France (1988)
- Germany (1991)
- Hong Kong (1994)
- India (1998)
- China (2001)
By 1997, the agency was rating approximately $5 trillion in securities from 20,000 U.S. and 1,200 non-U.S. issuers. However, this growth was accompanied by increased scrutiny, including lawsuits from issuers, Department of Justice investigations, and criticism following the Enron scandal and the 2008 financial crisis.
In 1998, Dun & Bradstreet sold the publishing arm to Financial Communications (later Mergent). On September 30, 2000, Moody's Investors Service was spun off into a separate publicly traded company. Despite having fewer than 1,500 employees at the time, the division had accounted for roughly 51% of Dun & Bradstreet's profits the previous year. In the five years following the spin-off, Moody's share value increased by over 300%.
The Structured Finance Boom and the 2008 Crisis
Between 1998 and 2007, structured finance—financial instruments like mortgage-backed securities (MBS) and Collateralized Debt Obligations (CDOs)—became a primary growth driver for Moody's. Revenue from these products increased more than fourfold, accounting for nearly 50% of rating revenues between 2005 and 2007.
Questions later arose regarding the models used to rate these products. In June 2005, Moody's updated its approach for estimating default correlation for non-prime mortgages. This model relied on 20 years of data characterized by rising housing prices and low delinquencies, which did not account for a potential market downturn.
The consequences became clear in 2007. On July 10, Moody's downgraded 399 subprime mortgage-backed securities issued the previous year. Three months later, it downgraded another 2,506 tranches totaling $33.4 billion. By the end of the crisis, Moody's had downgraded 83% of all 2006 Aaa mortgage-backed security tranches and all of the Baa tranches.
More recently, in June 2013, Moody's Investor Service warned that Thailand's credit rating could be negatively impacted by a costly rice-pledging scheme that lost 200 billion baht ($6.5 billion) between 2011 and 2012.
Key Facts
- Founder: John Moody established the first company in 1900.
- Innovation: First to widely publish bond ratings in an accessible format and charge subscription fees.
- The Big Three: Moody's is part of the dominant trio alongside Standard & Poor's and Fitch.
- Revenue Shift: Transitioned from investor-paid to primarily issuer-paid ratings by 1970.
- NRSRO Status: Recognized by the SEC in 1975 as a Nationally Recognized Statistical Rating Organization.
- 2008 Impact: Downgraded 83% of 2006 Aaa mortgage-backed security tranches following the subprime crisis.
| Year | Event | Significance |
|---|---|---|
| 1900 | Founding of John Moody & Company | Launch of the first market assessment manual. |
| 1914 | Incorporation of Moody's Investors Service | Formalization of the rating agency structure. |
| 1936 | New Banking Laws | Banks restricted to "investment grade" bonds. |
| 1970 | Introduction of Issuer Fees | Shift in revenue model to charge bond issuers. |
| 2000 | Public Spin-off | Became a separate publicly traded company. |
| 2007 | Subprime Downgrades | Massive re-rating of mortgage-backed securities. |
Frequently Asked Questions
Who invented modern bond credit ratings?
John Moody is credited as the inventor of modern bond credit ratings, having published the first wide-scale market assessments in 1900.
What is the difference between investment grade and junk bonds?
Investment grade bonds are considered lower risk and are approved for bank investment, while "speculative investment securities" (junk bonds) are higher risk and were prohibited for bank investment under 1936 U.S. laws.
What is an NRSRO?
An NRSRO is a Nationally Recognized Statistical Rating Organization, a designation given by the SEC to agencies whose ratings are accepted for regulatory purposes, such as determining capital requirements for broker-dealers.
How did Moody's revenue model change over time?
Initially, Moody's charged investors subscription fees to access ratings. In 1970, the company began charging the issuers of the bonds, a model that eventually accounted for approximately 90% of revenue by 2005.
Why did Moody's downgrade so many securities in 2007?
Moody's downgraded a vast number of subprime mortgage-backed securities because the models used to rate them were based on 20 years of rising home prices and low delinquencies, which failed to predict the subprime mortgage crisis.