Insight

Downgrade the raters

Researchers find out that despite the poor showing of rating agencies, regulators increased their reliance on them

Rating agencies gained importance in the 1930s thanks to the Great Depression. However, their role in forecasting the risks of sovereign debt, an important segment of the bond market, was not particularly impressive. Despite this, these agencies have continued to grow in importance, perhaps defying logic. Marc Flandreau, Norbert Gaillard and Frank Packer have found that despite the poor showing of rating agencies, regulators increased their reliance on them. The reaction of the agencies during the foreign debt crisis in the 1930s was typical (delays in reacting and then massive downgrades), but the fact that regulators based their regulations on these ratings has been found to be the exact opposite of what experts advise now.

 

Title: To err is human: rating agencies and the interwar foreign government debt crisis, Working Paper No. 335;

Source: The Bank for International Settlements

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