August 11, 2009

Examining Proposals to Enhance the Regulation of the Credit Rating Agencies

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There is strong sentiment expressed in current proposals for more extensive regulation of the credit rating agencies in hopes of forestalling future financial debacles. The heightened regulation of the rating agencies is likely to discourage entry, rigidify a specified set of structures and procedures, and discourage innovation in new ways of gathering and assessing information, new technologies, new methodologies, and new models (including new business models)—and may well not achieve the goal of inducing better ratings from the agencies.  Ironically, it will also likely create a protective barrier around the incumbent credit rating agencies. A better route would start with the recognition that the centrality of the three major rating agencies for the bond information process was mandated by more than 70 years of prudential financial regulation of banks and other financial institutions. Hence, the regulatory reliance on ratings must be eliminated, and market forces must be brought to bear.