Stop Mandating Reliance on Ratings
By Lawrence White, Robert Kavesh Professorship in Economics & Deputy Chair of Economics
The alternative is continued regulation of the raters, which would make the Big Three raters even more important. Why would anybody want that?
There’s an understandable urge to further regulate bond raters to prevent such mistakes in the future.
But, such regulation is likely to discourage smaller rating firms, who could well be sources of new ideas, methodologies and, technologies.
Some have called for an end to the "issuer-pays" model, where whoever is issuing the bond pays for its rating. But ratings of corporate, municipal, and sovereign government bonds have had the "issuer-pays" model for over 40 years and have not experienced anything like the severe problems that arose in mortgage bonds.
Instead, there is a better way. Eliminate the government’s regulatory reliance on ratings. Since the 1930s, financial regulators have required many financial institutions to heed the ratings of a handful of raters. The goals of the regulators were good: making sure those institutions’ portfolios held safe bonds. But mandating reliance on the Big Three enhanced their importance and made it harder for other rating firms to compete with them.
Read full article as published in The New York Times.
More Opinions by Lawrence White
- "Streaming Poses Ultimate Catch-22," 5.15.13
- Professor Lawrence White Comments on the SEC’s Rule 17g-5 Program at the SEC, 5.14.13
- "Stop Mandating Reliance on Ratings," 2.19.13
- "Taking the L-I-E Out of Libor," 7.26.12
- "Ticket Buyers Deserve to Have Their Rights Protected," 6.12.12
- "Europe's War on Downgrades," 11.4.11