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Markets: The Credit Rating Agencies


  • Lawrence J. White


This paper will explore how the financial regulatory structure propelled three credit rating agencies -- Moody's, Standard & Poor's (S&P), and Fitch -- to the center of the U.S. bond markets -- and thereby virtually guaranteed that when these rating agencies did make mistakes, these mistakes would have serious consequences for the financial sector. We begin by looking at some relevant history of the industry, including the series of events that led financial regulators to outsource their judgments to the credit rating agencies (by requiring financial institutions to use the specific bond creditworthiness information that was provided by the major rating agencies) and when the credit rating agencies shifted their business model from "investor pays" to "issuer pays." We then look at how the credit rating industry evolved and how its interaction with regulatory authorities served as a barrier to entry. We then show how these ingredients combined to contribute to the subprime mortgage debacle and associated financial crisis. Finally, we consider two possible routes for public policy with respect to the credit rating industry: One route would tighten the regulation of the rating agencies, while the other route would reduce the required centrality of the rating agencies and thereby open up the bond information process in a way that has not been possible since the 1930s.

Suggested Citation

  • Lawrence J. White, 2010. "Markets: The Credit Rating Agencies," Journal of Economic Perspectives, American Economic Association, vol. 24(2), pages 211-226, Spring.
  • Handle: RePEc:aea:jecper:v:24:y:2010:i:2:p:211-26 Note: DOI: 10.1257/jep.24.2.211

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    References listed on IDEAS

    1. Mathis, Jérôme & McAndrews, James & Rochet, Jean-Charles, 2009. "Rating the raters: Are reputation concerns powerful enough to discipline rating agencies?," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 657-674, July.
    2. Jorion, Philippe & Liu, Zhu & Shi, Charles, 2005. "Informational effects of regulation FD: evidence from rating agencies," Journal of Financial Economics, Elsevier, vol. 76(2), pages 309-330, May.
    3. Gorton, Gary B., 2008. "The panic of 2007," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 131-262.
    4. Flandreau, Marc & Gaillard, Norbert & Packer, Frank, 2009. "Ratings Performance, Regulation and the Great Depression: Lessons from Foreign Government Securities," CEPR Discussion Papers 7328, C.E.P.R. Discussion Papers.
    5. Gary Gorton, 2008. "The Panic of 2007," Yale School of Management Working Papers amz2372, Yale School of Management.
    6. Calomiris Charles W, 2009. "A Recipe for Ratings Reform," The Economists' Voice, De Gruyter, vol. 6(11), pages 1-4, November.
    7. Lawrence J. White, 2006. "Good Intentions Gone Awry: A Policy Analysis of the SEC's Regulation of the Bond Rating Industry," NFI Policy Briefs 2006-PB-05, Indiana State University, Scott College of Business, Networks Financial Institute.
    8. Efraim Benmelech & Jennifer Dlugosz, 2010. "The Credit Rating Crisis," NBER Chapters,in: NBER Macroeconomics Annual 2009, Volume 24, pages 161-207 National Bureau of Economic Research, Inc.
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    14. Morkötter, Stefan & Westerfeld, Simone, 2009. "Rating model arbitrage in CDO markets: An empirical analysis," International Review of Financial Analysis, Elsevier, vol. 18(1-2), pages 21-33, March.
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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation


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