As the most severe financial and economic crisis since the Great Depression unfolds, scholars, practitioners, and regulators have been studying its causes and possible cures to prevent similar crises in the future. At the center of the crisis is the explosive growth of the mortgage-backed securities (MBS) market, which is both fueled by and fueling the housing market boom. In this paper, we study an important piece of the evolution of the MBS market the rating agencies (Moody’s and S&P in particular) and their role in the expansion of the MBS market.
Specifically, we examine whether conflicts of interest lie behind the growth of MBS, and whether and when the market began to realize this incentive in practice. We ask, in particular, did the rating agencies grant large mortgage originators, who brought substantial business, unduly favorable ratings?