April 18, 2007
Comment on File Number S7-04-07.
Dear Ms. Morris:
I am supportive of attempts to foster competition in the credit rating industry.
Due to multiple information asymmetries, the credit rating industry is a very complex one. Behavior that appears non-competitive at first sight can well be part of an efficient solution that the market has evolved into.
I am particularly concerned about the proposed rule 240.17g-6 (4):
4) Issuing or threatening to issue a lower credit rating, or lowering or threatening to lower an existing credit rating, or refusing to issue a credit rating or withdrawing a credit rating, with respect to securities or money market instruments issued by an asset pool or as part of any asset-backed or mortgage-backed securities transaction, unless a portion of the assets which comprise the asset pool or the asset-backed or mortgaged-backed securities also are rated by the rating organization(...)
I do not regard the practice of notching to be addressed by this rule as evidence of non-competitive behavior. Rating agencies' concerns about the credit quality of issuers not rated by themselves are very likely to be legitimate. Empirical academic research, for example, shows that issuers can successfully shop for a rating that is biased upwards. In consequence, restricting notching and related practices as proposed in 240.17g-6 (4) could lead to a situation in which structured finance ratings are less informative than they are at present.
For the sake of brevity, I refrain from detailing the argumentation because other commenters (e.g. Darrell Duffie, Charles Calomiris et al), whose views I endorse, have already done this.
Professor of Finance
University of Ulm