Explanation:
The agency problem in question is one where the interests of the principal (the originator of the structured financial assets) and the agent (the credit rating agency) are not aligned. In an ideal scenario, a credit rating agency should provide an unbiased and accurate assessment of the financial assets. However, in this case, the agencies were being paid by the originators for their services. This created a conflict of interest, as the agencies had a financial incentive to issue favorable ratings to increase their chances of being rehired by the originators. This is a classic example of an agency problem, where the agent acts in their own best interest at the expense of the principal. The fact that the agencies were making more money from rating structured financial assets than they would have from rating corporate bonds further exacerbated this problem.
Choice A is incorrect. While it's true that credit rating agencies may have an interest in promoting certain financial assets, this does not directly constitute an agency problem. An agency problem arises when there is a conflict of interest between the agent (in this case, the credit rating agency) and the principal (the investors relying on the ratings). The demand for structured financial assets does not inherently create such a conflict.
Choice B is incorrect. This statement suggests that government pressure was a primary factor influencing credit rating agencies' overly positive ratings. However, while government policies can influence market conditions and indirectly affect ratings, they do not represent an inherent agency problem within the structure of credit rating agencies themselves.
Choice C is incorrect. Although mathematical modeling could potentially lead to flawed ratings, this would not qualify as an agency problem. In addition, there's little evidence to suggest that credit rating agencies were deploying flawed models. They could assess the proper rating correctly but chose to go with exaggerated ratings in an attempt to appease issuers and continue making money.
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Q.417 During the period leading up to the 2007-2008 financial crisis, credit rating agencies were frequently observed to provide overly positive ratings and forecasts for structured financial assets. This practice was seen as problematic and indicative of a certain agency problem. What was the specific agency problem that was at play in this scenario?
A
Structured financial assets initially had very low demand, and credit rating agencies wanted to push that demand up.
B
Credit rating agencies were under considerable pressure from the federal government to issue favorable ratings that would stir the economy and lead to growth.
C
Credit rating agencies depended heavily on sophisticated mathematical models, which failed to accurately predict the risk of these structured financial assets.
D
Credit rating agencies would get paid by originators of structured financial assets for their work, and also made more money than they would otherwise have made from rating corporate bonds.