Abstract
Credit ratings pose an interesting paradox. On one hand, credit ratings are enormously valuable and important. Rating agencies have great market influence and even greater market capitalization. Credit rating changes are major news; 2 rating agencies play a major role in every sector of the fixed income market. Credit ratings purport to provide investors with valuable information they need to make informed decisions about purchasing or selling bonds, and credit rating agencies seem to have impressive reputations. The market value of credit ratings was confirmed on September 30, 2000, when Moody’s Corp. became a free-standing publicly-traded entity. The market capitalization of Moody's as of April 2002 was more than $6 billion.
Professor, University of San Diego School of Law. I am grateful for comments from participants in a conference on The Role of Credit Reporting Systems in the International Economy, sponsored by the University of Maryland Center for International Economics, the New York University Stem School of Business, and the World Bank, and held at the World Bank in Washington, D.C., on March 1-2, 2001, and particularly to Professors Richard Levich and Lawrence White , and to the University of San Diego School of Law for financial support.
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Refenreces
See, e.g., Galen Hite & Arthur Warga, The Effect of Bond-Rating Changes on Bond Price Performance, Financial Analysts Journal, May/June 1997, at 35–47.
Interview with Thomas L. Friedman, The NewsHour With Jim Lehrer (PBS television broadcast, Feb. 13, 1996).
See Richard Sylla, A Historical Primer on the Business of Credit Ratings, 2001 working paper, at 25–26.
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Stephen Choi, Market Lessons for Gatekeepers, 92 Nw. U. L. Rev. 916, 934 (1998) (emphasis added).
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Roy C. Smith & Ingo Walter, Rating Agencies: Is There An Agency Issue?, 2001 working paper, at 33.
See, e.g., Adam Smith, Lectures on Justice, Police, Revenue, and Arms, Edwin Cannan, Ed. 253–54 (Augustus M. Kelley, New York 1964).
See Standard & Poor’s Debt Rating Criteria: Industrial Overview 3 (1986).
The single exception to this one-for-one matching was Moody’s) which did not use the D category of ratings at the time.
See Gilbert Harold, Bond Ratings as an Investment Guide: an Appraisal of Their Effectiveness 90 (1938).
Harold, Bond Ratings as an Investment Guide, at 46.
Harold, Bond Ratings as an Investment Guide, at 21.
Harold, Bond Ratings as an Investment Guide, at 22.
See Gustav Osterhus, Flaw- Tester for Bond Lists, 29 Am. Bankers Assoc. J., Aug. 1931, at 67; see also Gilbert Harold, Accuracy in Reading the Investment Spectrum, 27 Am. Bankers Assoc. J., July 1934, at 32.
See Richard House, Ratings Trouble, Institutional Inv., Oct. 1999, at 245.
See George E. Pinches & J. Clay Singleton, The Adjustment of Stock Prices to Bond Rating Changes, 33 J. Fin. 29, 38 (1978). There were numerous studies of the effects of credit rating changes on market prices in the Journal of Finance during this period, in part because the performance of the rating agencies had been so abysmal. See, e.g., Frank K. Reilly & Michael D. Joehnk, The Association Between Market-Dominated Risk Measures for Bonds and Bond Ratings, 31 J. Fin. 1387 (1976); George E. Pinches & Kent A. Mingo, A Multivariate Analysis of Industrial Bond Ratings, 28 J. Fin. 1 (1973).
See Conditions of Membership in the Federal Reserve System, at 1 (mimeographed bulletin, Federal Reserve Board, Washington, 1933); Membership of State Banks and Trust Companies, Regulation H, at 5 (Federal Reserve Board, Washington, 1930).
See Gustav Osterhus, Flaw-Tester Bond Lists, 29 Am. Bankers Assoc. J., Aug. 1931, at 68ff.
Mimeographed ruling issued by J.W. Pole, then Comptroller of the Currency, not dated, although other references indicated that the ruling was made on September 11, 1931, see 133 The Commercial and Financial Chronicle 1672 (Sept. 12, 1931).
See Wall St. J., Sept. 12, 1931, at 1, 5.
See Harold, Bond Ratings as an Investment Guide, at 27–28 (citing adoptions of Montana, Mississippi, Alabama, Oregon, Ohio, and New York).
Paragraph 7 of Section 5136 of the Revised Statutes of the U.S., as amended by Section 308 of the Banking Act of 1935.
Regulations governing the Purchase of Investment Securities, and Further Defining the Term “Investment Securities” as Used in Section 5136 of the Revised Statutes as Amended by the “Banking Act of 1935,” Sec. II, issued by the United States Comptroller of the Currency, Washington, February 15, 1936).
Harold, Bond Ratings as an Investment Guide, at 31.
Harold, Bond Ratings as an Investment Guide, at 35; see also id. at v.
See S&P Debt Ratings Criteria, at v.
See Pinches & Singleton, at 31.
House, Ratings Trouble, at 245.
Moody’s Corp. 10Q Statements.
See Notice of Revision Proposed Amendments to Rule 15c3-1 under the Securities Exchange Act of 1934, Release No. 34-10,525, 1973 Sec Lexis 2309 (Nov. 29, 1973) (“The Commission to a limited extent has also recognized the usefulness of the nationally recognized statistical rating organizations as a basis for establishing a dividing line for securities with a greater or lesser degree of market volatility”). The term “NRSRO” is mentioned in Rule 15c3-1, but is not defined in any other regulation; other regulations simply refer to Rule 15c3-1. See, e.g., 17 C.F.R. 270.2a-7 (Rule 2a-7, defining the term “as that term is used in Rule 15c3-1”).
For a more complete treatment, see Frank Partnoy, The Siskel and Ebert of Financial Markets: Two Thumbs Down for the Credit Rating Agencies, 77 Wash. U.L.Q. 619 (1999).
See Federal Reserve Regulation H. (Mar. 14, 2000) (interim rule establishing NRSRO-based criteria for financial subsidiaries of banks).
See Frank Partnoy, Siskel & Ebert, at ••.
Smith & Walter, at 35.
See also Item 10(c) of Regulation S—K.
182 Pa. 407, 38 A. 527 (1897).
273 Pa. 341,117 A. 54 (1922).
249 N.Y. Supp. 758, 762 (1931).
See Cantor & Packer, The Credit Rating Industry, at 4; Francis A. Bottini, Jr. An Examination of the Current Status of Rating Agencies and Proposals for Limited Oversight of Such Agencies, 30 Sandibgol. Rev. 579, 584–95 (1993); County of Orangey. McGraw-Hill Cos., No. SA 94-22272 JR (June 11, 1996).
See Partiloy, Siskel and Ebert, at 690–703.
See, e.g., Suzanne Woolley, et al., Now It’s Moody’s Turn for a Review, Bus. Week, April 8, 1996, at 116.
See Quimi v. McGraw-Hill, 168 F.3d 331 (7th Cir. 1999).
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Partnoy, F. (2002). The Paradox of Credit Ratings. In: Levich, R.M., Majnoni, G., Reinhart, C.M. (eds) Ratings, Rating Agencies and the Global Financial System. The New York University Salomon Center Series on Financial Markets and Institutions, vol 9. Springer, Boston, MA. https://doi.org/10.1007/978-1-4615-0999-8_4
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