Ruined in a Conventional Way: Responses to Credit Ratings’ Role in Credit Crises

Matthews, David J. | January 1, 2009

In 2007, abuses in the U.S. mortgage industry precipitated a financial crisis that led regulators in the United States and in the European Union to reexamine credit rating agencies. Asset-backed securities bearing agency ratings helped spread the effects of the crisis to diverse institutional investors, including European banks. This article traces debt securities and ratings from the rise of the mortgage securitization industry to the European and U.S. responses following the 2007 meltdown and concludes that ratings-focused regulatory changes are only a first step in avoiding similar financial crises. The market incentives, risk misperception, and risk spreading that attend complex finance in the global market require further improvements to capital adequacy requirements, credit rating practices, and market participants’ understanding of investor psychology.