Journal of Economic Perspectives
ISSN 0895-3309 (Print) | ISSN 1944-7965 (Online)
Markets: The Credit Rating Agencies
Journal of Economic Perspectives
vol. 24,
no. 2, Spring 2010
(pp. 211–26)
(Complimentary)
Abstract
This paper will explore how the financial regulatory structure propelled three credit rating agencies -- Moody's, Standard & Poor's (S&P), and Fitch -- to the center of the U.S. bond markets -- and thereby virtually guaranteed that when these rating agencies did make mistakes, these mistakes would have serious consequences for the financial sector. We begin by looking at some relevant history of the industry, including the series of events that led financial regulators to outsource their judgments to the credit rating agencies (by requiring financial institutions to use the specific bond creditworthiness information that was provided by the major rating agencies) and when the credit rating agencies shifted their business model from "investor pays" to "issuer pays." We then look at how the credit rating industry evolved and how its interaction with regulatory authorities served as a barrier to entry. We then show how these ingredients combined to contribute to the subprime mortgage debacle and associated financial crisis. Finally, we consider two possible routes for public policy with respect to the credit rating industry: One route would tighten the regulation of the rating agencies, while the other route would reduce the required centrality of the rating agencies and thereby open up the bond information process in a way that has not been possible since the 1930s.Citation
White, Lawrence J. 2010. "Markets: The Credit Rating Agencies." Journal of Economic Perspectives, 24 (2): 211–26. DOI: 10.1257/jep.24.2.211JEL Classification
- G01 Financial Crises
- G24 Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies
- G28 Financial Institutions and Services: Government Policy and Regulation
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