29 Pages Posted: 27 Mar 2015
Date Written: December 31, 2013
For decades credit rating agencies were viewed as trusted arbiters of creditworthiness and their ratings as important tools for managing risk. The common narrative is that the value of ratings has been compromised by the evolution of the industry to a form where issuers pay for ratings. In this paper we show how credit ratings have value in equilibrium and how reputation insures that in equilibrium ratings will reflect the correct assessment of credit worthiness. There will always be an information distortion because of the fact that purchasers of ratings need not reveal them. We argue that regulatory reliance on ratings and the increasing importance of risk-weighted capital in prudential regulation have more likely contributed to distorted ratings than the matter of who pays for them. In this respect, much of the regulatory obsession with the conflict created by issuers paying for ratings is misguided.
Keywords: Ratings Agencies, Mortgaged-Backed Securities, Great Recession
JEL Classification: G2, E44
Suggested Citation: Suggested Citation