The Who have that song “Won’t be fooled again” Â . Â Are the folks at the rating agencies whistling that song? Â 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”. Â In my preferred world, Â rating agencies would be randomly assigned to the party that they will rate. Â 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. Â Don’t believe me? Â Well, listen to these fat cats.
These guys are looking for the “straight talk express” and the Ratings Agencies know this. Â A big question in modern game theory is how do you build up a credible reputation? Â So, if you want to be perceived as tough — do you punch a bully or invade a nation? Â The Ratings Agencies are now trying to signal that they are a credible source of information. Â 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. Â Do the agencies have the “human capital” to do the research right? Â Well, I would need more information to answer this.