Why Lehman? Well, there are three stark similarities that also mirror as fundamental differences.

Debt, ratings and credit rating agencies.

Let’s start with debt. The defining term of the 2008-era subprime bubble was collateralised debt obligations (CDOs) – complex debt instruments packaged with individual fixed income assets. CDOs were sliced and diced ad infinitum till nobody knew what they contained or what they were worth. These CDOs, which were then sold across the world to banks, mutual funds, pension funds, and insurance companies, turned out to be junk. Which then set off a chain reaction pushing the entire global economy into recession.

In IL&FS’ case, debt is still the reason. The labyrinthine group with 347 different subsidiaries had total consolidated borrowings of Rs 91,000 crore (~$12.5 billion) as of March this year. Out of this Rs 24,297 crore (~$3.3 billion) (26.35%) was raised through debentures and around Rs 5,752 crore (~$785 million) (6.3%) through commercial paper (CP), as per a report by brokerage firm Nomura. Needless to say, many banking and financial institutions in India have lent to IL&FS.

Number two is ratings.

CDOs enjoyed super safe AAA ratings until companies started to file for bankruptcy, after which they went toxic and were conveniently reduced to default grade.

IL&FS enjoyed a AAA credit rating as late as August 2018. But after the crisis started to get talked about, the ratings started to fall. Ratings firm ICRA Ltd first decided to drop its rating by a level to AA+. Then, in September, ICRA and others like Fitch Ratings and CARE Ratings downgraded it to default after the parent and a host of subsidiaries defaulted.

Which brings us to the third similarity – credit rating agencies, or CRAs – essential gatekeepers of the financial ecosystem, who were caught napping.

The string of defaults by IL&FS and the sudden downgrade by rating agencies have created a panic in the Indian capital market and cast doubt on the credibility of rating agencies’ work. “Beginning from the failures from the 2008-09 crisis and the current scenario of IL&FS and two years back with office equipment company Ricoh India, all these are living examples of the message that rating agencies are not serving the purpose for which they were created,” says JN Gupta, former Executive Director of Securities and Exchange Board of India (Sebi) and MD of proxy advisory firm Stakeholder Empowerment Services.

“If [ratings agencies] fail to advise or fail to detect the future problems or some sort of a signal, then the question arises: what are they for?” Gupta says.

Debt is the new Black

Corporate bonds accounted for as much as 30% of outstanding system credit in FY18, as per credit rating agency CRISIL’s latest Yearbook in the Indian Debt Market. This is up from 21% in FY13.

The report further expects corporate bond outstanding to more than double to Rs 55-60 lakh crore (~$754-823 billion) by FY23, compared to around Rs 27 lakh crore (~$370 billion) at the end of FY18.

At a simple level, there are three key players in the bond market – issuers, buyers and raters. Issuers are the borrowing companies or institutions raising debt by offering interest. Buyers are the lenders.

Between them lies an important player, whose opinion matters a lot but has no skin in the game if a borrower goes bust – the raters, or credit-rating agencies. Each issuer (or borrower) or its debt offering is assigned a rating, without which, due to regulation, a debt instrument cannot be issued. The objective of ratings is to ostensibly make investors aware of the business health of the issuer and of its ability to continue servicing its debt. A rating is, thus, a creditworthiness assessment.

Except, that it isn’t really.

While the “opinions” of rating agencies can move markets, open or shut the tap for liquidity, and even play a major role in bringing a global recession, they have virtually zero downside risk to their own profits when they go wrong.

Which happens more often than you would think.

In the case of IL&FS, concerns around its viability started being raised nearly three years ago, as the rot in its finances became visible.

For starters, India’s central bank, the RBI itself, had expressed concerns about the operations of an IL&FS subsidiary, IL&FS Financial Services (IFIN). In its annual inspection for the year 2014-15, it had pointed out that the net-owned funds of the finance company had been wiped out and that it was over-leveraged.