A blog on financial markets and their regulation
Rating Agencies: What changed in 2000s?
January 19, 2014Posted by on
Consider three alternative descriptions of what happened to the big global rating agencies during the early 2000s:
- Kedia, Rajgopal and Zhou wrote a paper last year presenting evidence showing that the deterioration of Moody’s credit rating was due to its going public and the consequent pressure for increasing profits.
- Bo Becker and Todd Milbourn wrote a paper three years ago arguing that increased competition from Fitch coincides with lower quality ratings from the incumbents (S&P and Moody’s).
- Way back in 2005, Frank Partnoy wrote a highly prescient paper describing the transformation of the rating industry since the 1990s that turned “gate keepers” into “gate openers”. He attributed the very high profitability of the gate openers to three things: (a) the regulatory licences that made ratings valuable even if they were uninformative, (b) the “free speech” immunity from civil and criminal liability for malfeasance and (c) the rapid growth of CDOs and structured finance.
I find Partnoy’s paper the most convincing despite its total lack of econometrics. The sophisticated difference-in-difference econometrics of the other two papers is, in my view, vitiated by reverse causation. When rating becomes “a much more valuable franchise than other financial publishing” as Partnoy showed, there would be greater pressure to do an IPO and also greater willingness to disregard any adverse reputational effects on other publishing businesses of the group. Similarly, the structural changes in the industry would invite greater competition from previously peripheral players like Fitch who happen to hold the same regulatory licence.