Material Detail

As financial market complexity and borrower diver- sity have grown over time, investors and regulators have increased their reliance on the opinions of the credit rating agencies. At the same time, the number of rating agencies operating in the United States and abroad has risen sharply. Together, these trends have prompted market participants and policymakers to assess the performance of the agencies and the adequacy of public oversight of the ratings industry.

This article provides background for such a reassessment by investigating the evolution and eco- nomics of the industry, the growth of ratings-dependent regulations, and the reliability and comparability of the agencies’ ratings. We examine the correspondence of ratings with default rates and report differences among major agencies in their ratings for junk bonds, interna- tional banks, and mortgage-backed securities.

Our findings raise several questions about the current uses of ratings. While the agencies provide accurate rank-orderings of default risk, the meanings of specific ratings vary over time and across the agencies. Since these ratings are used as the basis of most investor guidelines and government regulations, the variations in meaning could have serious implications. In light of the possibhties for ratings misuse, the current reevalu- ation of ratings-dependent regulations and the adequa- cy of public oversight seems well justified.