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How to Reform the Credit-Rating Process to Support a Sustainable Revival of Private-Label Securitization

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Listed:
  • Richard Herring

    (The Wharton School, University of Pennsylvania, 2444 Steinberg-Dietrich Hall, 3620 Locust Walk, Philadelphia, PA 19104, USA)

  • Edward J. Kane

    (Boston College, 2325 E Calle Los Altos, Tucson, AZ 85718, USA)

Abstract

US product-liability laws unwisely treat credit-rating organizations (CROs) as if they produce opinions rather than empirically-based economic research. In principle, trained professionals gather time-varying information ("financial news") and analyze it statistically to reduce it to a single dimension, allegedly for the benefit of investors, which, in turn, enables issuers to finance themselves at lower cost. In practice, the issuer-pays business model currently used for funding the production and distribution of ratings information creates an incentive to favor high-volume issuers by over-rating private-label securitizations. While the Dodd–Frank Act intensifies SEC oversight of CRO activity, the SEC has a history of being captured by regulatory clients. We argue that the fundamental solution is to create accountability in the ratings process so that private label securitizations can play a constructive role in the provision of credit and we go on to offer some conjectures about how this could be done.

Suggested Citation

  • Richard Herring & Edward J. Kane, 2012. "How to Reform the Credit-Rating Process to Support a Sustainable Revival of Private-Label Securitization," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 2(01), pages 1-25.
    • Handle: RePEc:wsi:qjfxxx:v:02:y:2012:i:01:n:s2010139212500024
    DOI: 10.1142/S2010139212500024
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    References listed on IDEAS

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    1. Adrian, T. & Shin, H S., 2009. "The shadow banking system: implications for fi nancial regulation," Financial Stability Review, Banque de France, issue 13, pages 1-10, September.
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    4. Utzig, Siegfried, 2010. "The Financial Crisis and the Regulation of Credit Rating Agencies: A European Banking Perspective," ADBI Working Papers 188, Asian Development Bank Institute.
    5. Richard Herring & Edward J. Kane, 2010. "Rating "Agencies": How Regulation Might Help," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 8(1), pages 14-23, 04.
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