Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Reforming the rating agencies

In my last
on my vacation reading, I was rather contemptuous of the
efforts of the New York Attorney General and of IOSCO to reform the
rating agencies, but Joshua Rosner goes
much further
. He says that the Attorney General’s proposal
will actually reward the rating agencies, and I think he is right.

Rosner also has some very sensible suggestions for genuine reforms
at the end of his post. I agree with all of them and also think that
they are genuinely workable:

  • Requiring that any regulated institution that was required to
    invest only in highly rated securities should generally hold only
    securities listed on a major exchange. They would be allowed to hold
    non-exchange traded securities only if they were able to demonstrate
    to examiners their own independent analysis in support of rating
    agency assessments.
  • Reducing the structured finance liability exemptions for rating
  • When a rating agency finds that their model needs to be updated or
    corrected the rating agency should be required to, on a timely basis,
    re-rate all existing securities that were rated using the prior
  • [For structured products], the rating agencies should be required
    to automate an objective method of utilizing the originally modeled
    assumptions and re-rating the security monthly using the original
    assumptions, originally assumed loss curve and tied to the monthly
    servicer remittance reports.
  • A qualified team that is fire-walled from revenue line pressures
    and reports directly to a committee of independent Board members
    should create ratings models.


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