Credit Default Swap Spreads as Viable Substitutes for Credit Ratings

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In
response to the recent financial crisis, commentators have criticized
certain credit rating agencies, known as Nationally Recognized Statistical
Rating Organizations (NRSROs), and credit default swaps
(CDSs). Regulators have proposed a range of reforms
in both areas but have not considered the links between them.
This Article considers one potential link: whether CDS markets
could play a role in financial reform related to NRSROs.

More
specifically, one set of proposals suggests that legislators and regulators
reduce the dysfunctional incentives associated with overreliance on
NRSRO credit ratings. Although there is support for
this proposal in theory, one objection forestalling
reform has been that, notwithstanding the problems associated with credit
rating agencies, there do not appear to be viable substitutes for credit
ratings. Indeed, ongoing skepticism and criticism about CDS markets
has reinforced the objection. In simple terms, the objection is
that regulators and investors should not replace one broken system (credit
ratings) with another broken system (CDSs).

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