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Just before the collapse of the subprime mortgage market in $2007,$ the most important credit$-$rating agencies rated mortgage$-$backed securities with Aaa and AAA ratings.

Explain how it was possible that a few months into $2008,$ the same securities had the lowest possible ratings.

A$.$ The govemment revoked tax exemption to investors for these securities$,$ thereby lowering returns and ratings.

B$.$ As inflation soared in early $2008,$ returns on mortgage$-$backed securities was wiped out. Many AAA$-$rated products had to be downgraded to junk status.

C$.$ When housing prices began to fall and subprime mortgages began to default, many AAA$-$rated products had to be downgraded over and over again.

Should we always trust credit$-$rating agencies?

A$.$ No$.$ The credit rating agencies lack the mathematics and technology to assign correct ratings to securities$.$

B$.$ No$.$ Sometimes there are conflicts of interests in credit$-$rating agencies.

C$.$ Yes. The credit$-$rating agencies are involved with structuring products that they rate. This ensures that their ratings are often accurate. Sometimes credit rating agencies also make mistakes in assigning risks.