Academic

So much for my ability to make political predictions.  I thought that the logical first target of financial reform would be the rating agencies.  Everyone seemed to agree that have repeatedly done a poor job in predicting bond defaults -- from the Enron era (and before!) up to the current crisis.  The rating agencies don't seem to have large political constituencies. 

So what happened?  A tepid set of SEC regulations -- encouraging new NRSROs (say that 10 times backwards) to register with the commission, imposing a few conflict of interest rules, requiring a few new disclosures from the NRSROs on their historical performance in making downgrades -- but nothing spectacular.  Not surprisingly, limited reforms have had limited success.  No new rating agency has achieved significant market share.  It isn't clear what additional disclosures will actually do.  With the big rating agencies enjoying both government-granted oligopoly power (see Partnoy) and a first-mover advantage, do investors have a meaningful choice? 

We could ask, per Claire Hill, why anyone pays attention to rating agencies any more?  Going back to Partnoy, one answer is that rating agency determinations are hardwired into a multitude of securities, banking, and insurance regulations.  If various regulated financial entities want to invest in debt, they must find securities rated "investment grade" by an NRSRO. 

Which brings us back to my ineptitude at political prediction and the question in the title of this post - "how have rating agencies escaped?"  Public choice provides a simple answer - it isn't surprising that a small group of institutions with a big stake in regulation and significant resources can stop meaningful reform. 

But there is a deeper problem suggested by Partnoy's scholarship.  What would we replace rating agency ratings with?  As noted above, myriad financial regulations delegate to ratings the basic function of regulating risk-taking by financial institutions.  What would we replace ratings with?  I'll explore some ideas in later posts.  But the rating agency oligopoly is not easily undone -- the agencies are deeply embedded in U.S. regulation.