Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Fri, 23 Jun 2006

Partnoy on Rating Agencies

Frank Partnoy has an interesting paper entitled “How And Why Credit Rating Agencies Are Not Like Other Gatekeepers”. I have talked about rating agencies on this blog here and here. Partnoy brings several new insights into this discussion.

Partnoy also has an extended discussion criticizing the way ratings agencies rate CDOs and argues that CDOs are there only because of rating arbitrage: “Put another way, credit rating agencies are providing the markets with an opportunity to arbitrage the credit rating agencies’ mistakes”. I would not agree with this part of Partnoy’s analysis. The intense competition between the two major rating agencies to produce better CDO rating models would rather suggest that rating arbitrage is a passing phase in a maturing market.

But Partnoy has written a very informative and thought provoking paper on rating agencies. I entirely agree that the time has come to eliminate the regulatory use of ratings completely.

Posted at 18:40 on Fri, 23 Jun 2006     3 comments     permanent link


Neil Carthy wrote on Mon, 03 Jul 2006 19:07

Re: Partnoy on Rating Agencies

I agree with the assumption that competition will reduce the prevalence of CDO rating arbitrage but it will never eliminate it. A prospective CDO investor would be well advised to treat any "interesting" or non-standard deal as ratings-arbitraged, regardless of the salesman's spin.

Per Kurowski wrote on Fri, 24 Aug 2007 06:32

Re: Partnoy on Rating Agencies

I absolutely agree… when in a hole stop digging! It was an excessive confidence in the risk assessment from the rating agencies that managed to catapult what should only have been a small local problem of badly awarded mortgages into a global mass confusion. And that excessive confidence sprang out of the fact that our regulators going against what all human wisdom should have taught them empowered the credit rating agencies to implicitly and explicitly decide so much about where market should go.

The real truth we have to face is that the better the credit rating agencies get at what they are supposed to do the larger the chances for the build up of systemic risks and the bigger the ensuing explosion.

I am not against credit rating agencies. I will use them. But let the markets be free from having to use them… since otherwise what will happen is that 100% of our pension funds are going to end up in illiquid junk, beautifully dressed up in AAA ratings.