Recently in Regulation of Rating Agencies Category

The Senate's passage of its version of the financial regulatory reform bill, like its House of Representatives' counterpart (H.R. 4173), presents a mixed bag of reforms for the role of the credit rating agencies in the debt markets of the U.S.  Both bills instruct financial regulators to cease relying on ratings in their prudential regulation of banks and other financial institutions.  This is all to the good.  It is the near-deification of the three large rating agencies, as a consequence of over 70 years of such regulatory reliance on ratings, that greatly magnified the disastrous consequences of their over-optimism with respect to the creditworthiness of subprime residential mortgage based securities.

But both bills also pile on new regulatory requirements on rating agencies, which will surely add to the costs of being a credit rating agency and will discourage entry and thus discourage new ideas, new methodologies, new technologies, and new business models.  Because the large incumbents are better able to absorb these costs, an ironic consequence of these requirements is that the three incumbents could well become more important, not less.  Do the authors of these provisions realize this?

Finally, the Senate bill contains the "Franken Amendment", which instructs the SEC to create a clearinghouse board to which issuers of RMBS that sought a rating would apply.  Though the issuer would continue to pay for the rating, the "shopping around" by the subprime RMBS issuers would be eliminated, since the clearinghouse would select the rater.  If this provision survives the reconciliation of the two versions of the bill, it will be crucial for the clearinghouse to maintain high standards of rating quality and to be open to innovation in ways of determining the creditworthiness of bonds.

by Edward I. Altman, Sabri Oncu, Anjolein Schmeits, and Lawrence J. White

The three large global credit rating agencies - Moody's, Standard & Poor's, and Fitch - were central players in the subprime residential mortgage debacle of 2007-2008. Their initial overly optimistic ratings on mortgage-related securities encouraged the housing boom and bubble of 1998-2006. When house prices ceased rising and began to fall, mortgage default rates rose sharply, and the prices of the mortgage bonds cratered (as did their ratings), wreaking havoc throughout the U.S. financial system.

The Securities and Exchange Commission has already expanded its regulation of the rating agencies, and congressional legislation may well insist on more. But to understand the proper route forward, it's important to understand how we got to where we are today.


The Dodd-Frank Act, signed into law in July 2010, represented the most significant and controversial overhaul of the U.S. financial regulatory system since the Great Depression. Forty NYU Stern faculty, including editors Viral V. Acharya, Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter, provide a definitive analysis of the Act, expose key flaws and propose solutions to inform the rules’ adoption by regulators, in a new book, Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance (Wiley, November 2010).

About Restoring Financial Stability

Previously, many of these faculty developed 18 independent policy papers offering market-focused solutions to the financial crisis, which were published in a book, Restoring Financial Stability: How to Repair a Failed System (Wiley, March 2009).

About the Authors