Reforming the Selection of Rating Agencies in Securitization Markets: A Modest Proposal

Milken Institute Review, Forthcoming

7 Pages Posted: 23 Dec 2016

See all articles by Howard Esaki

Howard Esaki

Retired, Former Head of Structured Finance Research, S&P

Lawrence J. White

New York University (NYU) - Leonard N. Stern School of Business, Department of Economics

Date Written: November 23, 2016

Abstract

One of the roots of the 2008 financial crisis was a deterioration of rating agency standards, which contributed to the widespread defaults in the residential mortgage-backed securities (RMBS) sector. In this paper we suggest a change to the rating agency selection process that removes much of the incentive for rating agencies to lower their standards so as to expand their business.

In its simplest form, our proposal is similar to the process that applies to judging panels at some Olympic events: The most lenient judge is dropped. In the context of rating agencies, the most lenient rater is dropped, or the rating fee is withheld. Our proposal would apply not only to RMBS, but also to commercial mortgage-backed securities (CMBS), collateralized loan obligations (CLOs), and other asset-backed securities (ABS), such as auto and credit card receivables.

If rating agencies’ incentives for competitively lowering their standards are diminished, the argument for increased direct regulation of the agencies by the Securities and Exchange Commission (SEC) is similarly diminished.

Keywords: rating agencies, agency standards

Suggested Citation

Esaki, Howard and White, Lawrence J., Reforming the Selection of Rating Agencies in Securitization Markets: A Modest Proposal (November 23, 2016). Milken Institute Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2889490

Howard Esaki

Retired, Former Head of Structured Finance Research, S&P ( email )

No Address Available

Lawrence J. White (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business, Department of Economics ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

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