Regulation, Market Structure, and Role of the Credit Rating Agencies

Abstract

In this paper, we argue that the financial markets would have been better served had the credit rating agency industry been more competitive. We will show that the Securities and Exchange Commission’s (SEC) designation of Nationally Recognized Statistical Rating Organizations (NRSROs) inadvertently created a de facto oligopoly primarily propping up three firms: Moody’s, S&P, and Fitch. We will also explain the rationale behind the NRSRO designation given to CRAs and demonstrate that it was not intended to serve as an oligopolistic mechanism, but rather a mechanism intended to protect consumers. Although CRAs were indirectly constrained by their reputational value among investors, the lack of competition in the marketplace likely allowed for greater complacency in ratings’ methodologies. We also contend that government regulatory use of credit ratings inflated market demand for NRSRO CRA ratings despite decreasing informational value of credit ratings.

Keywords: Credit Rating Agencies, Oligopoly, Public Policy, Regulation, Markets, 2008 Financial Crisis