Prudence with Biased Experts: Ratings Agencies & Regulators

45 Pages Posted: 24 Sep 2010  

David M. Levy

George Mason University - Center for Study of Public Choice

Sandra J. Peart

University of Richmond - Jepson School of Leadership Studies

Date Written: September 23, 2010

Abstract

Why were the rating agencies trusted? When they became required for Federal deposit insurance their incentives for upward bias was common knowledge. The requirement was attacked by a Chicago economist, Melchior Palyi, on philosophical grounds (the expertise is excessively secret) and technical (Moody’s forecasts were inaccurate). The Federal government financed a massive study of bond ratings which developed a technical response to remove the bias. The study required a trade with the rating agencies so the authors wrote prudently to avoid offending the agencies. They disguised the meaning of their procedures and did not discuss the full dimensions of Palyi’s challenge. When the technical methods failed, the loss of memory did not allow us to recover Palyi’s warning about non-transparency.

Keywords: Rating agencies, NBER, Corporate Bond Project, FDIC, Melchior Palyi, Gilbert Harold, Leo Crowley, worst-case estimation

JEL Classification: A11, B23, B31, G01, G24

Suggested Citation

Levy, David M. and Peart, Sandra J., Prudence with Biased Experts: Ratings Agencies & Regulators (September 23, 2010). Available at SSRN: https://ssrn.com/abstract=1681609 or http://dx.doi.org/10.2139/ssrn.1681609

David M. Levy (Contact Author)

George Mason University - Center for Study of Public Choice ( email )

MSN 1d3 Carow Hall
4400 University
Fairfax, VA 22030
United States

Sandra J. Peart

University of Richmond - Jepson School of Leadership Studies ( email )

Jepson Hall
Richmond, VA 23173
United States

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