Abstract

The first half of this presentation will provide quantitatively-based evidence of the severe problems with the major credit rating agencies such as Moody’s and Standard and Poors. We will begin with a relatively simple quantitative model of the credit risk of corporate debt that was far more successful than major rating agency ratings in predicting downgrades and defaults during the global financial crisis.  Our next key point will be a review of the clear flaws in the methodology used by the rating agencies for complex mortgage securities and CDOs. Our final evidentiary point will be an empirical examination of the more effective predictive performance of smaller rating agencies such as Lace Financial and AM Best.   The latter half of the presentation provides a prescriptive five-point plan for improving the usefulness and predictive power of agency ratings without requiring that the ratings business and regulatory structure of financial service firms be radically altered.