Prudence with Biased Experts: Ratings Agencies & Regulators

46 Pages Posted: 3 Oct 2010

See all articles by David M. Levy

David M. Levy

George Mason University

Sandra J. Peart

University of Richmond - Jepson School of Leadership Studies

Date Written: October 1, 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 nontransparency.

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

Suggested Citation

Levy, David Milton and Peart, Sandra J., Prudence with Biased Experts: Ratings Agencies & Regulators (October 1, 2010). GMU Working Paper in Economics No. 10-32. Available at SSRN: https://ssrn.com/abstract=1686135 or http://dx.doi.org/10.2139/ssrn.1686135

David Milton Levy (Contact Author)

George Mason University ( email )

Carow Hall
Fairfax, VA 22030
United States
703-993-2319 (Phone)

Sandra J. Peart

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

Jepson Hall
Richmond, VA 23173
United States

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