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The Economists' Voice 2.0The Financial Crisis, Health Care Reform, and More$
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Joseph Stiglitz and Aaron Edlin

Print publication date: 2014

Print ISBN-13: 9780231160155

Published to Columbia Scholarship Online: November 2015

DOI: 10.7312/columbia/9780231160155.001.0001

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A Recipe for Ratings Reform

A Recipe for Ratings Reform

(p.89) Chapter 11 A Recipe for Ratings Reform
The Economists' Voice 2.0

Charles W. Calomiris

Columbia University Press

This chapter considers the role of credit ratings agencies in the recent financial crisis. The evidence of rating agency failure shows up in inflated ratings and low-quality ratings. The inflation of ratings is the purposeful underestimation of default risk on rated debts. Low-quality ratings are ratings based on flawed measures of underlying risk. The recent collapse of subprime-related securitizations revealed both problems in the extreme. The elimination of the use of ratings for regulatory purposes would remove some of the incentive for ratings inflation, but, by itself, would not solve the problem of inflated and low-quality ratings. Any solution to the problem must make it profitable for rating agencies to issue high-quality, non-inflated ratings, notwithstanding the demand for low-quality, inflated ratings by institutional investors. This can only be accomplished by objectifying the meaning of ratings and linking fees earned by rating agencies to their performance. If fees are linked to the quality of objectified ratings, then ratings agencies would find it unprofitable to cater to buy-side preferences for inflated, low-quality ratings.

Keywords:   credit ratings agencies, financial reform, financial regulation, credit risk, inflated ratings, low-quality ratings

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