Financial Economists Roundtable Statement on Reforming the Role of the Rating “Agencies” in the Securitization Process

Assets securitized by private companies reached a peak of nearly $12 trillion in 2008, an amount nearly equal to the entire stock of credit intermediated in traditional ways by the world's banking systems. Failures of care and diligence in the origination, rating, and securitization of subprime mortgages led to a collapse in the prices of securitized assets and the public's confidence in the reliability and integrity of the process by which securities are rated. This decline in confidence has in turn undermined prices and credit flows in every market where investors and regulators rely on the credit ratings provided by Statistical Ratings Organizations (SROs) to certify the quality of debt. With the aim of rebuilding confidence in the securitization process, this statement drafted and signed by 30 distinguished academic economists recommends three kinds of reform that are designed to improve the incentives faced by the SROs. First, to increase accountability for ratings mistakes, the analytic work of SROs must be made more transparent and their managements must accept liability for errors of negligence. Second, explicit reliance on ratings should be eliminated from risk management regulations issued by government agencies. By effectively “outsourcing” public authority to private firms, such regulations have had the effect of intensifying SRO conflicts of interest. Finally, SROs should be required to calculate and state express margins for error in the ratings for every tranche of securitized instruments. This would help investors appreciate the differences in the degree of leverage embedded in various categories of securitized debt.