Monday, September 1, 2008
Rating Risk after the Subprime Mortgage Crisis: A User Fee Approach for Rating Agency Accountability, by Jeffrey Manns, Latham & Watkins, was recently posted on SSRN. Here is the abstract:
This article argues that rating agencies succumbed to temptations to compromise their role as screeners of credit risk due to an absence of accountability, which paved the way for the subprime mortgage crisis. It will suggest how enlisting the purchasers of debt issues, the primary beneficiaries of ratings, as self-interested monitors of rating agencies may help to heighten rating agency accountability in the future. The combination of rating agency autonomy and interconnections of interests with their clients, issuers of debt, led rating agencies to provide false assurances on the risk exposure of subprime mortgage collateralized debt obligations (CDOs). Purchasers of subprime mortgage CDOs suffered significant losses due in part to their reliance on inaccurate ratings, yet lacked any means to hold rating agencies accountable. For this reason, the article suggests how creditors may bear both the burdens and benefits of rating agency accountability by financing ratings through an SEC-administered user fee system in exchange for enforceable rights. This innovative approach would create a principal-agent relationship between the beneficiaries of screening roles and gatekeepers. It will show how subjecting certification and mandatory reporting duties to creditors to a gross negligence standard and an earnings-based cap on liability exposure will create incentives for rating agency compliance, yet pose a manageable burden.