Working Paper: CEPR ID: DP7556
Authors: Marco Pagano; Paolo Volpin
Abstract: This paper examines the role of credit rating agencies in the subprime crisis that triggered the 2007-08 financial turmoil. The focus of the paper is on two aspects of ratings that contributed to the boom and bust of the market for asset-backed securities: rating inflation and coarse information disclosure. The paper discusses how regulation can be designed to mitigate these problems in the future. The suggestion is that regulators should require rating agencies to be paid by investors rather than by issuers (or at least constrain the way they are paid by issuers) and force greater disclosure of information about the underlying pool of securities.
Keywords: credit rating agencies; crisis; default; liquidity; securitization; transparency
JEL Codes: D82; G18; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Conflict of interest between CRAs and investors (G24) | Ratings inflation (E31) |
| Ratings inflation (E31) | Misleading investors (G24) |
| Misleading investors (G24) | Contribution to financial crisis (F65) |
| Loss of detailed information about underlying assets (G19) | Market illiquidity (G19) |
| Coarse information disclosure by CRAs (G24) | Loss of critical information (D89) |
| Loss of critical information (D89) | Market freeze when defaults occur (E44) |
| Market freeze when defaults occur (E44) | Exacerbating illiquidity (E44) |