Document Type

Article

Publication Date

2011

Center/Program

Center for Contract and Economic Organization

Center/Program

Center for Law and Economic Studies

Abstract

Although dissatisfaction with the performance of the credit rating agencies is universal (particularly with regard to structured finance), reformers divide into two basic camps: (1) those who see the "issuer pays" model of the major credit ratings firms as the fundamental cause of inflated ratings, and (2) those who view the licensing power given to credit ratings agencies by regulatory rules requiring an investment grade rating from an NRSRO rating agency as creating a de facto monopoly that precludes competition. After reviewing the recent empirical literature on how ratings became inflated, this Article agrees with the former school and doubts that serious reform is possible unless the conflicts of interest inherent in the "issuer pays model" can be reduced. Although the licensing power hypothesis can explain the contemporary lack of competition in the ratings industry, increased competition is more likely to aggravate than alleviate the problem of inflated ratings. Still, purging conflicts is no easy matter, both because (1) investors, as well as issuers, have serious conflicts of interest (for example, investors dislike ratings downgrades) and (2) a shift to a "subscriber pays" business model is impeded by the public goods nature of credit ratings. This Article therefore reviews recent policy proposals and considers what steps could most feasibly tame the conflicts of interest problem.

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