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.

• “Before the 1970s, when the Securities and Exchange Commission created the NRSRO designation and various regulations began to depend on NRSRO ratings, credit rating agencies made money by charging subscription fees to investors, not ratings fees to issuers. In contrast, today roughly 90 percent of credit rating agencies’ revenues are from issuer fees.”
• “As of early September 2005, Moody’s market capitalization was more than $15 billion ... Moody’s share price trades at a significantly higher multiple than the typical publicly traded gatekeeper, such as an investment bank.”
• “Although Moody’s might say that it is in the financial publishing business, market participants do not believe it. Moody’s is substantially smaller than the other major financial publishers and generates less revenue than they do, but it has a much higher market capitalization. ... Investors will pay five times more for a dollar of Moody’s revenue than for a dollar of the revenues of Dow Jones or Reuters. Each Moody’s employee is associated with ten times more market value than each Dow Jones or Reuters employee. By virtually any financial measure, Moody’s has a much more valuable franchise than other financial publishing firms and is much too profitable to be considered a financial publisher. If Moody’s were in the same business as financial publishing firms, one would expect these ratios to be close.”

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 6:40 pm IST on Fri, 23 Jun 2006         permanent link

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