Regulating the Credit Rating Agencies? Less Would Be More

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Lawrence White, Jan 28, 2014

The three major credit rating agencies -Moody’s, Standard & Poor’s , and Fitch-continue to receive widespread media and policy attention. Since 2008 the Securities and Exchange Commission has expanded its regulation of the CRAs-partly on its own initiative and partly as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Injured investors-primarily pension funds-have sued the CRAs. In early 2013 the U.S. Department of Justice sued S&P for fraud. All of these events have attracted substantial media attention, as do proposals for new CRAs.

The major CRAs surely wish that all of this attention would evaporate; but it is likely to persist. Their excessive optimism with respect to mortgage-related securities in the middle years of the decade of the 2000s made them important for the housing bubble of that era and then in the financial crisis that followed.

However, as many disgruntled commentators have noted, despite the heightened attention little has changed: The same three CRAs still dominate the ratings business. Their ratings-and especially downward changes in their ratings-still attract media attention and often move markets. And the same troubling business model that seemed to encourage that excessive optimism-they are paid by the issuers of the bonds that the CRAs rate-still prevails among the major CRAs and even among most of the smaller ones.

So, what needs to change? Is more regulation needed? Better regulation? Maybe less regulation? Is there a role for antitrust? After all, there are only three CRAs that dominate the ratings business-and have done so for decades. Is more competition needed? If so, how might it be created?

This essay will argue that public policy should remove the pedestal on which past policy has placed the major CRAs. Their deification should be revoked, which should allow less (but better focused) regulation and more competition.