GOVERNMENT REGULATIONS MONOPOLIZE THE CREDIT RATING INDUSTRY
February 4, 2005
Requirements by the Securities and Exchange Commission for credit rating agencies create barriers to entry for other firms. As a result, two firms dominate the market in a government-sponsored "credit rating cartel," says Alex Pollock of the American Enterprise Institute.
Credit ratings are used by investors and financial institutions to determine the perceived credit risk of securities issuers, and federal and state laws require many financial institutions to issue only highly-rated securities. However, the supply of credit agencies is limited:
- Two dominant firms, Standard & Poor's and Moody's, represent about 80 percent of sector revenue.
- In 2003, Moody's after tax return on investment was 74 percent; its operating profit margin was 55 percent.
- Such profitability would not likely be sustained in a competitive market.
The problem, says Pollock, is that credit rating agencies are subject to approval by the SEC as "nationally recognized statistical rating organizations" (NRSRO). Thirty years ago, NRSRO implied that an agency was accepted by the marketplace. But today the designation presents a catch-22 for new firms: the SEC must designate credit agencies as NRSRO before they get the chance to widely participate in the market, but they must have market acceptance before they can receive the NRSRO designation.
- Dropping the "NRSRO" designation, and instead, simply refer to an agency approved by the SEC as an ?SEC-approved rating agency.?
- Eliminating the catch-22 of the SEC requiring its approval of rating agencies while before they can participate in the market.
- Doing away with the regulatory requirement of designation of approved rating agencies; instead, place the responsibility of choosing among rating agencies on investors, financial firms and others that use rating.
Source: Alex J. Pollock, "End the Government-Sponsored Cartel in Credit Ratings," American Enterprise Institute, January 2005.
Browse more articles on Economic Issues