Assessing Proposed Solutions to Bias in Credit Ratings

Most market observers attribute the recent credit crunch to a confluence of factors: lax screening by mortgage originators, improperly estimated correlation between bundled assets, market-distorting regulations, and a bubble in financial services. In addition, most agree that inflated credit ratings played an important role in facilitating the market exuberance leading up to the crash. This leaves many policy makers asking what laws might prevent ratings bias in the future. To answer this question, it is important to understand the sources of ratings bias.

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Originally published at Stern on Finance and reproduced here with the author’s permisison.