Prudence with Biased Experts: Ratings Agencies & Regulators
45 Pages Posted: 24 Sep 2010
Date Written: September 23, 2010
Why were the rating agencies trusted? When they became required for Federal deposit insurance their incentives for upward bias was common knowledge. The requirement was attacked by a Chicago economist, Melchior Palyi, on philosophical grounds (the expertise is excessively secret) and technical (Moody’s forecasts were inaccurate). The Federal government financed a massive study of bond ratings which developed a technical response to remove the bias. The study required a trade with the rating agencies so the authors wrote prudently to avoid offending the agencies. They disguised the meaning of their procedures and did not discuss the full dimensions of Palyi’s challenge. When the technical methods failed, the loss of memory did not allow us to recover Palyi’s warning about non-transparency.
Keywords: Rating agencies, NBER, Corporate Bond Project, FDIC, Melchior Palyi, Gilbert Harold, Leo Crowley, worst-case estimation
JEL Classification: A11, B23, B31, G01, G24
Suggested Citation: Suggested Citation