The Who have that song “Won’t be fooled again” . Are the folks at the rating agencies whistling that song? In a repeated game, reputation matters. If ratings agencies want to continue to attract business, they have incentives to build a reputation as a “trusted straight shooter”. In my preferred world, rating agencies would be randomly assigned to the party that they will rate. This would negate conflict of interest issues that clearly arose and helped to cause “junk” to receive a AAA rating.
A silver lining of the 2008 Crisis is that there is more doubt in investors’ minds about the increased chance of “fat tail” risk. Don’t believe me? Well, listen to these fat cats.
These guys are looking for the “straight talk express” and the Ratings Agencies know this. A big question in modern game theory is how do you build up a credible reputation? So, if you want to be perceived as tough — do you punch a bully or invade a nation? The Ratings Agencies are now trying to signal that they are a credible source of information. I think they have the right incentives now to do the basic research to provide an accurate forecast (given all available information) about future default risk. Do the agencies have the “human capital” to do the research right? Well, I would need more information to answer this.