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Regulation, Market Structure, and Role of the Credit Rating Agencies
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Regulation, Market Structure, and Role of the Credit Rating Agencies

Emily McClintock Ekins and Mark A. Calabria
Cato Institute, 2012
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Editorial Rating

8

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  • Controversial
  • Innovative
  • Background

Recommendation

Moody’s, Standard & Poor’s and Fitch emerged as unexpected villains of the housing market collapse. This detailed, enlightening report from the Cato Institute provides a valuable primer on the history of the credit rating agencies and the regulatory scheme they rode to prominence. Emily McClintock Ekins and Mark A. Calabria illuminate the accomplishments and misdeeds of these agencies. Considering the free-market leanings of this think tank, their conclusions are no surprise: Don’t blame the rating agencies, Cato says. Instead, blame the regulators who gave them too much power and too little incentive to innovate. One note: If you don’t align with the Cato Institute’s conservative ideology, you might not find this report convincing. getAbstract suggests it to investors and issuers seeking perspective and insight into the world of rating agencies.

Summary

Rating Agencies: From Watchdog to Lapdog?

In the decades leading up to the 2008 financial crisis, the dominant credit rating agencies – Fitch, Standard & Poor’s (S&P), and Moody’s – gained a reputation for financial acumen. The agencies used that reputation to generate consistent profits and outsized influence. They have served investors’ best interests for a long time, thought they have faced scrutiny in recent years.

The 61% drop in value of American International Group’s (AIG) shares after the three agencies downgraded its rating in September 2008 illustrates the raters’ power but also their flaw. Markets viewed the rating agencies as omnipotent. Investors, regulators and politicians effectively outsourced independent scrutiny to Moody’s, S&P and Fitch. Those relying on the agencies were, in large part, institutional investors such as pension funds, banks, insurance companies and hedge funds – market players more than capable of doing their own due diligence.

Over the decades that followed the rating agencies’ great Depression-era success, high barriers to entry gave the three firms an oligopoly because the law required debt issuers to seek ratings...

About the Authors

Emily McClintock Ekins is a Cato research fellow, a PhD candidate at UCLA and director of polling at Reason Foundation. Mark A. Calabria directs financial regulation studies at the Cato Institute.

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