The Indian Anomaly: Rethinking Credit Rating Agency Regulation from the Economic Perspective of Hyman Minsky THE INDIAN ANOMALY: RETHINKING CREDIT RATING AGENCY REGULATION FROM THE ECONOMIC PERSPECTIVE OF HYMAN MINSKY Jodie A. Kirshner Abstract Policymakers have blamed credit rating agencies for the recent financial crisis - but they could be wrong. India can aid in understanding whether the agencies can still be relied upon as private "gatekeepers" in financial markets, or whether public institutions must take primary responsibility. The economist, Hyman Minsky, advocated for robust public regulation and a limited role for private actors. India can be seen as an example of his theories. If India's agencies cannot prevent speculative credit from causing future economic problems, the problems could suggest that more structural measures are necessary to counter instability, as Minsky predicted. Analyzing India and the credit rating agencies through the frame of Minsky's economic theories offers insights into how best to reform financial regulation to prevent future economic collapse. Author Jodie A. Kirshner was a visiting fellow at Columbia Law School's Center for Contract and Economic Organization. She is also a University Lecturer in Corporate Law at the University of Cambridge. The author wishes to thank the Business Associations section of the American Association of Law Schools, the Max Planck Institute for Comparative Public Law and International Law, Columbia Law School, the Asian Law and Economics Association, Curtis Milhaupt, Brian Cheffins, and Robert Howse. 2 Columbia Journal ofAsian Law, Vol. 27, No. 1 (2o13) INTRODUCTION 3 1. SETTING THE SCENE: WHAT'S NEXT FOR INDIA 6 A. Phase 1: India as "Firmly On the Growth Expressway" 6 B. Phase 1I: India as "Gasping Elephant" 9 II. PANNING WEST: BLAMING CONFLICTED RATING AGENCIES FOR THE FINANCIAL CRISIS 11 A. Agencies as "Gatekeepers": The "Referee in the Debt Game" 12 B. Egregious Behavior: "Market Share, Market Share, Market Share" 14 1. Senate Subcommittee Investigation 15 2. Securities and Exchange Commission Staff Examinations 16 3. European Studies 17 C. Getting Here: "How Can You Miss So Badly" 18 i. Adopting "Issuer Pays" Without New Regulation 18 2. Securitization and Increased Competition 20 D. Blaming the CRAs: "A Watchdog Paid By the Persons They Are to Watch" 23 III. COUNTER-NARRATIVE: HYMAN MINSKY AND THE ENDOGENEITY OF CRISES 24 A. Minsky's Theories: The Economy "Generates a Financial Structure Susceptible to Financial Crises" 26 B. Predicting Minsky's Reaction to Regulating Credit Rating Agencies: "No Simple Answer to the Problems of our Capitalism" 28 C. Minsky's Vision of the Crisis: "Financial Regulation is Both Indispensable and Imperfect" 32 IV. SPOTLIGHT INDIA: CONFLICTED RATING AGENCIES AND DELIBERATE DEREGULATION 34 A. More Conflicts of Interest: Credit Rating Agencies in India 35 1. Soaring Market Values 35 2. Conflicts of Interest 36 3. Diversification 38 B. Adherence to Minskyian Pardigms: Indian Market Development 39 1. Market Liberalization and Increased Cash Flow: Minsky Phase i? 39 2. Deregulation and Debt Accumulation: Minsky Phase 2? 42 3. Speculative Euphoria and Fragility: Minsky Phase 3? 44 CONCLUSION The Indian Anomaly: Rethinking Credit Rating Agency Regulation 3 INTRODUCTION Recent developments in India lend themselves to two diverging forecasts of its future.' The first predicts sustained growth: the narrative begins with the country liberalizing its economy, continues to its strong performance during the peak of the recent global financial crisis, and anticipates an accelerating trajectory that will eventually overtake the West.2 The second story ends differently: the economic bubble bursts, as India's financial indicators reverse and its development slows. 3 At the intersection of the two opposing visions are six Indian credit rating agencies ("CRAs"). 4 They earned large profits in recent years, and grew more influential.5 As India's debt markets have grown and diversified, the CRAs 6.have provided positive ratings to increasingly risky financial products. The accuracy of the Indian CRAs is relevant to a debate that has gained intensity in the West.7 One side has blamed the recent financial crisis on the payment model that domestic CRAs employ,8 in which the agencies charge the issuers of the products for the ratings.9 The arrangement misaligns incentives, by this argument, and causes the agencies to raise their ratings in order to attract and retain new clients.'" U.S. and European regulators have in large part accepted this explanation of unreliable credit ratings, some resulting in 'See infra Part I. 'See infra Part I.A. 3 See infra Part I.B. 4 See infra Part IV.A. 'See infra Part IV.A.i. 6 See infra Part IV.B.3 ; Tarun Jain & Raghav Sharma, Credit Rating Agencies in India: A Case ofAuthority without Responsibility, 3 COMPANY L.J. 89, 1o6 (20O8) (India), available at http://ssrn.com/abstract=nn553 ("[T]he Indian CRAs have made their foray into rating [structured finance] products."). 7 See, e.g., Amadou N.R. Sy, The Systemic Regulation of Credit Rating Agencies and Rated Markets, IMF WORKING PAPER, June 2009 at 3 (Int'l Monetary Fund, WP/o9/129, 2009), available at http://www.imf.org/external/pubs/ft/wp/2009/wp0 9 129 .pdf. 8 Douglas Wayne Arner, Kwong Wing Chau, Berry F.C. Hsu, Frederik Izak Hendrik Pretorius & Lifen Pu, Regulating Credit Rating Agencies in Hong Kong: Lessons from the Global Financial Crisis, 25 BANKING & FIN. L. REV. 361, 373 (2010). ' Claire Hill, Limits Of Dodd-Frank's Rating Agency Reform, 31 No. 5 BANKING & FIN. SERVICES POL'Y REP. 13, 13 (2012) ("[T]he agencies are paid by the issuers and the issuers can threaten to take their business elsewhere if they cannot get high ratings".) So See, e.g., Timothy E. Lynch, Deeply and Persistently Conflicted: Credit Rating Agencies in the Current Regulatory Environment, 59 CASE. W. RES. L. REV. 227, 256 (2009) (describing a study that demonstrated that the CRAs became less reliable in the period following their adoption of the "issuer-pays" model); See Hill, supra note 9, at 13 ("[T]he agencies have let themselves be bribed into giving high ratings even when such ratings are not warranted".). 4 Columbia Journal ofAsian Law, Vol. 27, No. 1 (2o13) bank failures," and they have undertaken to reduce the conflict of interest.'" Consequently, they have made few systemic changes, and they have not restricted trading of complex instruments, such as mortgage-backed securities.3 Others have found the response of the regulators too simplistic.'4 They have put forward rival views,'" represented by the theories of the economist Hyman Minsky. ,6 Minsky hypothesized that unless the state imposed structural obstacles, economies would expand until they crashed.' His writings suggested that simple - or "exogenous" - regulatory mechanisms, such as changing the way that CRAs are paid, could not substitute for robust public interventions on a structural - or "endogenous" level.' 8 "Aline Darbellay & Frank Portnoy, Credit Rating Agencies Under The Dodd-Frank Act, 30 No. 12 BANKING & FIN. SERVICES POL'Y REP. 1, 2 (2011) ("Lehman Brothers retained its investment-grade rating until a few days prior to collapsing"); EUROPEAN UNION COMMITrEE, HOUSE OF LORDS, 14TH REPORT OF SESSION 2008-09 HL PAPER io6-l, THE FUTURE OF EU FINANCIAL REGULATION AND SUPERVISION VOLUME 1: REPORT, at 17 (U.K.) ("DG Markt explained that the regulation of rating agencies is a necessary reaction to their 'massive failures' revealed by the financial crisis. They described the conflicts of interest created when the issuers of a securitised bond pays for a rating, rather than the investor."). 12 See infra Part lI.D. '3 See, e.g., Timothy J. Sinclair, Credit Rating Agencies and the Global Financial Crisis, 12 No. 1 ECONOMIC SOCIOLOGY (Max-Planck Institute for the Studies of Societies, Cologne, Germany), Nov. 201o at 4, available at http://econsoc.mpifg.de/archive/econsoc 12- i.pdf ("Although criticism of conflicts of interest may serve a useful political purpose, too much attention to issues at this level will produce complacency about the inherent volatility of global finance"); See infra Part I11. 14 See, e.g., R. Michael Gadbaw, Systemic Regulation of Global Trade and Finance: A Tale of Two Systems, 13 J. INT'L ECON. L. 551, 552-55 (2010). '5 See, e.g., Justin Lahart, In Time of Tumult, Obscure Economist Gains Currency, WALL ST. J., Aug. 18, 2007. Academic economists including C.J. Whalen, L. Randall Wray, Paul Davidson, Riccardo Bellofiore and Joseph Halevi, along with other practitioners and journalists, have called the crisis a "Minsky moment", see Alessandro Vercelli, A Perspective on Minsky Moments: The Core of the Financial Instability Hypothesis in Light of the Subprime Crisis, THE LEVY ECONOMICS INSTITUTE OF BARD COLLEGE WORKING PAPER NO. 579, Oct. 9, 2009 at 2 (2009). t6 Minsky, a Harvard-trained economist, taught on the faculties of Brown University, University of California at Berkeley, and Washington University in St. Louis, see Dimitri B. Papadimitriou & L. Randall Wray, The Economic Contributions of Hyman Minsky: Varieties of Capitalism and Institutional Reform, THE JEROME LEVY ECONOMICS INSTITUTE, WORKING PAPER NO. 217, Dec. 1997, at 1-3 (1997). 17 See infra Part III.A. 18 See infra Part III.C. See also, Jan Kregel, Is This the Minsky Moment for Reform of Financial Regulation? THE LEVY ECONOMICS INSTITUTE OF BARD COLLEGE WORKING PAPER NO. 586, Feb. 25, 2oo at 3 (2010) ("[Rlegulation of the system cannot be effective if it is simply based on measures produced to remedy and reverse the conditions generated by The Indian Anomaly: Rethinking Credit Rating Agency Regulation 5 Observing developments in India offers insights for resolving this tension. 9 It helps to illuminate whether private actors such as CRAs can be relied upon to regulate financial markets, so long as their incentives are aligned correctly, or if public institutions must instead retain primary responsibility for governance." This paper presents India as a case study in order to contribute to the existing literature on the Western debate, identifying the CRAs not simply as private actors, but as "gatekeepers" that participate in regulation. 22 The agencies controlled the flow of information about the quality of financial instruments and could influence public awareness of fraud.23 Part I begins by describing the precarious position of modern-day India, with its past economic growth poised either to continue or to decline. The paper then establishes the role that CRAs have played in Western markets and the reasons for blaming their payment model for the recent financial crisis. Part III rebuts the argument and explains how an economist such as Hyman Minsky would have interpreted the causes of the crisis. Part IV introduces the Indian CRAs and points out both their similarities to Western agencies and their differences. It then sets out the proposal that India's expanding debt markets and increased use of high-risk financial instruments can be seen as an example of Minsky's theories. The theories would portend that the regulation of the Indian CRAs would not protect the country from future economic weakening. The story of India awaits an ending. Though many variables interact, and diverse, legal, political, and cultural contexts shape the effects that rules have in different countries, India's future could nevertheless offer some guidance.' the current 'moment.' It needs to reformulate the structure of the financial system... the current approach... [applies] cosmetic changes."). '9 See infra Part IV. 20 See, e.g., Howell E. Jackson, Variation in the Intensity of Financial Regulation: Preliminary Evidence and Potential Implications, 24 YALE J. ON REG. 253, 254-55 (2007) (discussing potential "capacity of market mechanisms to police certain activities more efficiently than government oversight."). " Harry McVea, Credit Rating Agencies, the Subprime Mortgage Debacle and Global Governance: the EU Strikes Back, 59 INT'L & CoMP. L.Q. 701, 702 (2010) ("CRAs became 'important private makers of global public policy' and were widely seen as key drivers of global governance .... ). 22 See, e.g., Turmoil in U.S. Credit Markets: The Genesis of the Current Economic Crisis: Hearing Before the S. Comm. on Banking, Housing, and Urban Affairs, iioth Cong., 2nd Sess. 17 (2008) [hereinafter The Genesis of the Current Economic Crisis Hearings] (testimony of Eric Stein), available at http://www.banking.senate.gov/public/index.cf m?Fuseaction=Hearings.Hearing&HearinglD=6deeloc-eii5-4686-ge 4 o-ebceea2fcb6 ("The ratings industry became 'the de facto watchdog over the mortgage industry."'). 23 See, e.g., Lynne L. Dallas, Short-Termism, the Financial Crisis, and Corporate Governance, 37 J. CORP. L. 265, 331 (2012). 24 For a discussion of the embeddedness of rules, see, e.g., Dan Danielsen, Economic Approaches to Global Regulation: Expanding the International Law and Economics Paradigm, 10 J. INT'L Bus. & L. 23, 68 (2011). 6 Columbia Journal of Asian Law, Vol. 27, No. i (2o13) If the economy rebounds, the growth could suggest that private "gatekeepers" such as CRAs can effectively regulate markets, rendering the destabilizing effects of India's increased debt levels and use of complex financial products inconsequential. If so, then perhaps the West has correctly focused on "exogenous" reforms, such as mitigating conflicts of interest among CRAs, rather than seeking more systemic solutions. If, however, the Indian economy contracts, the reversal could suggest the need for the state to participate more meaningfully to counter behaviors that increase credit supplies and contribute to instability, as Minsky proposed. 5 Studying India's future thus contributes answers to three overlapping questions: i) how intensively financial markets should be regulated and by whom; z) whether policing by private actors provides an efficient substitute for government oversight; and 3) the extent to which market forces discipline financial actors. I. SETTING THE SCENE: WHAT'S NEXT FOR INDIA This section presents evidence for two possible scenarios of India's future. Over the past twenty-one years, the country has developed rapidly and integrated its economy with global markets. 6 More recently, however, its progress has appeared to slow, and a more pessimistic outlook has taken hold. 7 India's future economic path remains uncertain2 A. Phase 1: India as "Firmly On the Growth Expressway"2 9 Financial reforms have transformed India." Between 2004 and zoo8, the economy grew by close to ten percent each year.' Analysts at the investment bank Goldman Sachs predicted that the country would surpass the United States in GDP before 2050. 2 Its upward trajectory has promised to lift millions 25 See, e.g., McVea, supra note zl, at 702 ("[Tlhe use (and abuse) of credit ratings ... has today cast a long shadow over the ability of these 'gatekeepers to provide reliable signals upon which parties - investors, financial institutions and regulators - can make informed decisions."); See Kregel, supra note 18, at 3 ("Effective proposals can only emerge from analysis of the longer-term structural changes from the point of view of Minsky's financial fragility hypothesis."). 26 Afra Afsharipour, Rising Multinationals: Law and the Evolution of Outbound Acquisitions by Indian Companies, 44 U.C. DAvis L. REV. 1029, 1035-36 (2011). 27 See, e.g., India's Economy: A Bric Hits the Wall, THE ECONOMIST, May 31, 2012. 28 See, e.g., Victor Mallet, India Struggles to Restore Its Fortunes, FINANCIAL TIMES, Aug. 7, 2012. 29 GOLDMAN SACHS, BRICS AND BEYOND 12 (2007). 30 See Afsharipour, supra note 26, at 1054-55. s' See, e.g., Id. at 1035-36. 32 See GOLDMAN SACHS, BRICS AND BEYOND, supra 29, at ii. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 7 out of poverty, 33 and their increased consumption has seemed likely to integrate the country more closely with international markets.' India's economic leadership has extended along with its growth, as other countries have studied its strong performance during the financial crisis.35 During the peak of the crisis in 2009, its GDP continued to increase by seven percent, 36 as companies listed themselves on Indian stock exchanges 37 and the capital markets posted record highs. 3 ' By 2010, the economy resumed a growth rate of close to ten percent.39 By contrast, the American economy shrunk by 3.1% in 2009 and grew by only 2.4% in 2010.40 The Indian central bank, the Reserve Bank of India ("RBI"), had loaned equity to private banks, relaxed their capital requirements, and delayed collecting on loans, while countering declines in the rupee, India's currency, by allowing expatriate Indians to maintain domestic deposits. This success underscored the accomplishments of two decades of economic liberalization. 4 ' Beginning in 1991, India unshackled its closed economy by lowering trade tariffs and boosting exports. 3 Tariffs fell from 200% to fifteen percent, exports rose by a factor of 14, and trade increased by twenty-five percent." The state retreated from many industries, increasing competition.45 The stock markets rose as resurgent Indian companies sold shares to diverse international investors. 46 3 Rolls-Royces and Pot-Holes, THE ECONOMIST, Oct. 22, 2011. 3 K. G. Viswanathan, The Global Financial Crisis And Its Impact on India, 9 J. INT'L Bus. & L. 41, 46-47 (2010). 35 d. at 46. 36 Afsharipour, supra note 26, at 1035-36; Erik Wulff & Kiran Lingam, Franchising in India: A Brave New Frontier, 29 FRANCHISE LJ. 248, 248 (2010). 37 Viswanathan, supra note 34, at 47 (referring to foreign investment into the equity markets and rises in the Bombay Stock Exchange). 38 Shardul Shroff, Outlook on India 2oLo: Delivering on the Promise in Turbulent Times, 1815 PLI/Corp 63, 65 (2010). 39World Bank, Database of GDP growth, available at http://data.worldbank.org/ indicator/NY.GDP.MKTP.KD.ZG. 40 Id. 4, See, e.g., Pulling Every Lever, THE ECONOMIST, Feb. 4, 2012. 42 Viswanathan, supra note 34, at 46-47. 43Sarita Mohanty, Sarbanes-Oxley: Can One Model Fit All?, 12 NEw ENG. J. INT'L &COMP. L. 231, 235 n.15 (2006). 44 Viswanathan, supra note 34, at 48. 41 See, e.g., The Power and the Glory, THE ECONOMIST, Oct. 22, 2011. 46 See, e.g., Mohanty, supra note 43, at 236. 8 Columbia Journal of Asian Law, Vol. 27, No. 1 (2013) A unique and seemingly successful brand of capitalism has emerged.47 Some state influence over the private sector has persisted, and politically- connected family firms predominate.'8 Resource limitations have propelled the companies to improvise affordable products, and Western competitors have sought to learn their techniques.4 9 PepsiCo established a center in India to study their methods of "frugal innovation". 0 Indian engineers won a contest sponsored by Renault-Nissan to contribute ideas for cutting costs." Ultimately, Indian companies have demonstrated their new strength by acquiring Western firms, and many observers have predicted a prosperous future both for them and for the broader Indian economy.5" In 2007, the Indian metals company Hindalco acquired American-Canadian Novelis for $6 billion. 5 In 2o08, Tata Motors paid $2.3 billion to buy Jaguar and Land Rover from Ford. 54 The beverage arm of the Tata Group, Tata Tea, acquired the iconic British brand Tetley Tea, 55 and India's Mahindra & Mahindra undercut the American market leader John Deere in sales of small tractors to American farmers. $6 47 See infra text accompanying notes 48-51. 48 See, e.g., The Power and the Glory, supra note 45; The Bollygarchs' Magic Mix, THE ECONOMIST, Oct. 22, 2011; Adventures in Capitalism, THE ECONOMIST, Oct. 22, 2011; Mohanty, supra note 43, at 235. 4' The Hindi slang word, jugaad, is used to refer to the technique. See, generally, Reena Jana, India's Next Global Export: Innovation, BLOOMBERG BUSINESSWEEK, Dec. 2, 2009, available at http://www.businessweek.com/innovate/content/dec2009/id2oo9121_ 864965.htm; Karl Moore, The Best Way to Innovation? - An Important Lesson from India, FORBES, May 24, 2o11, available at http://www.forbes.com/sites/karimoore/2o11/ 05/24/the-best-way-to-innovation-an-important-lesson-from-india/; Tim Ferguson, Can 'Jugaad' Get to Core U.S. Problems?, FORBES, Apr. 5, 2012, available at http://www. forbes.com/sites/timferguson/2o12/o4/o5/can-jugaad-get-to-core-u-s-problems/. so Asian Innovation, THE ECONOMIST, Mar. 24, 2012. 51 Id. 12 See infra text accompanying notes 52-56. " Chidanand Rajghatta, Novelis Acquisition Puts Indian Stamp on Every Coke, Budweiser Can, TIMES OF INDIA, Feb. 14, 2007 (India), available at http://articles.timesofindia. indiatimes.com/2007-02-14/international-business/2787o627._novelis-hindalco-share- holders-customers-on-four-continents. I Heather Timmons, Ford Sells Land Rover and Jaguar to Tata, N.Y. TIMES, March 26, 2008. 15 Tetley Bagged by India's Tata, BBC NEws, Feb. 27, 2000, available at http://news. bbc.co.uk/1/hi/business/658724.stm. 56 James Crabtree, Mahindra Looks at International Acquisitions, FINANCIAL TIMES, Apr. 15, 2012. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 9 B. Phase II: India as "Gasping Elephant""7 Other observers, however, have not expected the accomplishments to last. 8 Despite economic growth and increased prosperity, indications of future problems have emerged. " The Indian economy has no longer appeared to be insulated from the downturn in global markets. 6 In 2012, its growth fell to 5.3%, the lowest rate in seven years. 6' Its dependence on borrowing foreign capital and on exporting to developed markets has left the count 7 vulnerable to decreases in the supply of global credit and foreign demand. Other financial indicators have also begun to change direction.63 Inflation has risen to more than seven percent, leading to predictions of stagflation. 6 4 The rupee hit record lows against the dollar, shedding a fifth of its value in the past year.6 I Defaults by rated corporations hit a ten-year high,6 and recent studies predicted that India could switch places with Indonesia in growth statistics for the emerging market economies.67 The efforts that the country undertook to stave off the financial crisis appear to have weakened its condition. 68 The central bank distributed money and took responsibility over portions of the economy, leaving the quality of its own assets poor.6 Approximately 4.6% of its outstanding loans have reached the brink of default.70 Meanwhile, poverty has persisted.7 ' The official numbers indicate that 29.8% of the population, or 350 million people, remain below the poverty 17 Leif Eskesen, India, HSBC GLOBAL RESEARCH REPORT, May 31, 2012., '8 See, e.g., Now Finish the Job, THE ECONOMIST, Apr. 15, 2012 (quoting the governor of the central bank stating, "We are not saying the economy is in the pink of health ... we should be concerned . . 59 See Part I. B. 60 See, e.g., Losing Its Magic, THE ECONOMIST, March 24, 2012. 61 James Crabtree, Bollygarchs at Bay, FINANCIAL TIMES, June 5, 2012. 62 See, e.g., Viswanathan, supra note 34, at 44-45. 63 See infra text accompanying notes 64-67. 64 Crabtree, supra note 61. 65 See Rupee and the Bears, THE ECONOMIST, Nov. 26, 2011. 66 Nupur Acharya, Indian Corporate Default Rate at Ten-Year High, WALL ST. J., Apr. 4, 2012. 67 Crabtree, supra note 61. 68 See infra text accompanying notes 69-70. 69 Reflections of Reality, THE ECONOMIST, Aug. 6, 2011. 70 My Conflicted Heart, THE ECONOMIST, Apr. 21, 2012. ' Wulff& Lingam, supra note 36, at 248. 10 Columbia journal ofAsian Law, Vol. 27, No. 1 (2o13) line. 7 India ranks as the poorest country among the emergent BRIC economies (Brazil, Russia, India, and China)' and the poorest member of the G-20. 74 Politicians appear to have struggled to promote business needs while also addressing the problems of the urban poor. 75 The economy has not expanded fast enough to support the creation of sufficient infrastructure, and many of its citizens still lack access to electricity and potable water. 6 As a demographic bulge reaches working age, ten million young people per year will need to find jobs over the next two decades.' Many obstacles, however, have seemed to stifle entrepreneurship and job creation. 78 State-controlled firms have accounted for close to half of corporate profits in India; family-owned companies have earned most of the rest. 79 The companies have sprawled into chains of holding companies, in order to compensate for deficiencies such as poor infrastructure, unreliable sources of8o labor and materials, and weak enforcement. They have built their own infrastructure and supply chains and have leveraged their size to gain influence.8 ' Outsiders have had limited ability to compete against them.i In addition, relations between the government and private companies have appeared to worsen. 8 Business leaders have protested burdensome regulations by investing abroad rather than in India.s' In May 2012, heads of the largest Indian telecommunications companies met with politicians in New Delhi to complain. 85 The chief executive of the Indian steel company 7' Tripti Lahiri, Is India Fudging Its Poverty Numbers, WALL ST. J., March 20, 2012. 3 See, e.g., A Bric Hits the Wall, supra note 27. 7' ECONOMIC SURVEY 2012-13: INDIA POOREST AMONG G2o NATIONS DESPITE GROWTH, INDIA TODAY, MAR. 15, 2012 (INDIA). 71 Wulff & Lingam, supra note 36, at 248. 6 See, e.g., Charles Runckel, Infrastructure India: A Long Road Ahead, Business-in- Asia.com (last visited Nov. 25, 2013), http://www.business-in-asia.com/asia/ infrastructure india.html. 7 Farewell to Incredible India, THE ECONOMIST, June 9, 2012. 78 See infra text accompanying notes 79-82. ' See, e.g., The Power and the Glory, supra note 45; See Afsharipour, supra note 26, at 1029, 1o83, io85. 80 Building India Inc., THE ECONOMIST, Oct. 22, 2011; Adventures in Capitalism, supra note 48; The Bollygarchs' Magic Mix, supra note 48; Umakanth Varottil, Evolution and Effectiveness of Independent Directors in Indian Corporate Governance, 6 HASTINGS Bus. L.J. 281, 288-89 (2010). 8i Looking for the Next Infosys, THE ECONOMIST, Oct. 22, 2011. 82 See, e.g., id.; Now Finish the Job, supra note 58. 8, See infra text accompanying notes 84-86. 84 Crabtree, supra note 61. 5 Id. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 11 ArcelorMittal threatened not to initiate any domestic projects for the next five 86years. What will the future hold? American CRAs have already cast votes against India's future.l In June 2012, Standard & Poor's and Fitch revised their outlooks on India from stable to negative.' 9Analysts at Standard & Poor's speculated that India could become the first of the BRICs to fail."0 II. PANNING WEST: BLAMING CONFLICTED RATING AGENCIES FOR THE FINANCIAL CRISIS Ironically, policymakers in America and Europe have viewed the CRAs as the villains of the most recent financial crisis.9 They alleged that these entities had conflicts of interest, because they adopted an "issuer-pays" model, in which the issuers of financial instruments paid the agencies to rate them.92 This model, they maintained, incentivized the agencies to award inflated scores, in order to please the issuers and retain their business. 93 Regulators concluded that the model resulted in inaccurate public information on default risk and that the inaccuracies caused the financial markets to crash. 94 This 8 6id. 8 See, e.g., Bruce Einhorn, India's Growth Story Dims on S&P Downgrade, BLOOMBERG BUSINESSWEEK, Apr. 25, 2012. 88 Penny MacRae, S&P Downgrades India Outlook to Negative, AGENCE FRANCE-PRESSE, Apr. 25, 2012. 89 Fitch downgrades India's outlook to 'negative', BBC NEWS, June 18, 2012. 90 Joydeep Mukherji & Takahira Ogawa, Will India Be the First BRIC Fallen Angel? STANDARD & POOR'S, GLOBAL CREDIT PORTAL, June 8, 2012. ' John C. Coffee, Ratings Reform: The Good, The Bad, and The Ugly, COLUMBIA LAW AND ECONOMICS WORKING PAPER No. 359, Sept. 2OO at 2 (2010) ("Broad consensus exists that inflated credit ratings and conflict-ridden rating processes played a significant role in exacerbating the 2oo8 financial crisis."); European Commission, Consultation by the Commission Services on Credit Rating Agencies (CRAs), July 31, 2008, available at http://europa.eu/rapid/pressReleasesAction.do?reference=IP/o8/224&format=HTML& aged=l&language=EN&guiLanguage=fr ("It is generally accepted that CRAs underestimated the credit risk of structured credit products and failed to reflect early enough in their ratings the worsening of market conditions"). The European Commission opened proceedings against Standard and Poor's in 2oo9, see Arner et. al, supra note 8, at 38o-8. " See, e.g., Dallas, supra note 23, at 288 ("As for credit rating agencies, they had a conflict of interest because the issuers of securities paid their fees"). 93 Stephane Rousseau, Enhancing the Accountability of Credit Rating Agencies: The Case for a Disclosure-Based Approach, 51 McGill L.J. 617, 629 (2005) (Can.), available at http://www.lawjournal.mcgill.ca/userfiles/other/5366167-Rousseaui.pdf. 94 FINANCIAL STABILITY FORUM, REPORT OF THE FINANCIAL STABILITY FORUM ON ENHANCING MARKET AND INSTITUTIONAL RESILIENCE, April 7, 2oo8, at 32, available at Columbia Journal of Asian Law, VoL. 27, No. 1 (2o13) section explains why and how the regulators have focused on eliminating the conflict of interests in order to prevent a future crisis. A. Agencies as "Gatekeepers": The "Referee in the Debt Game" 95 In 2oo8, Henry Paulson, the U.S. Treasury Secretary under President George W. Bush, presented a policy statement in which he emphasized the responsibility of the CRAs for the crisis. 6 The report indicated the depth of the certainty of the regulators that the agencies were corrupt, and their reliance on the agencies to perform a "gatekeeping" role."7 "Gatekeepers" deter fraud by monitoring financial markets and disseminating information. 8 For the last century, the CRAs facilitated financial investment by publishing assessments of the risks of buying financial products from specific issuers.9 9 When issuers sell financial products to investors, the products represent promises from the issuers that they will pay back the full purchase price at fixed installments, plus interest."° The investors therefore relied on the CRAs' assessments of the likelihood that the issuers would return all of the http://www.financialstabilityboard.org/publications/r-o8o4.pdf, ("Poor credit assessments by CRAs contributed both to the build up to and the unfolding of recent events."); The Genesis of the Current Economic Crisis Hearings, supra note 22, at 3 ("Being able to gather and understand relevant information about a company's financial health and performance is critical to the proper functioning of the markets."); Dallas, supra note 23, at 331 ("[Tlhe ratings on structured financial products have proven to be inaccurate ... contribut[ing] significantly to the mismanagement of risks by financial institutions and investors, which in turn adversely impacted the health of the economy"). " Arthur Levitt, Conflicts and the Credit Crunch, WALL ST. J., Sept. 7, 2007 at A15. 96 Sinclair, supra note 13, at 4. 97 THE PRESIDENT'S WORKING GROUP ON FINANCIAL MARKETS, POLICY STATEMENT ON MARKET DEVELOPMENTS, March, 2oo8, at 2, 4, 14-15, available at http://www.naic.org/documents/ committee' _e rating-agency-comdoc-presidentswg.pdf. 98 Rousseau, supra note 93, at 620 ("[T]hese institutions have become central to the financial markets' infrastructure through their role in rectifying information asymmetries that exist between issuers and investors."); Credit Rating Agencies and the Financial Crisis, Hearing Before H. R. Comm. on Oversight and Governmental Reform, 110 th Cong., 2n d Sess. 4 (2008) [hereinafter Credit Rating Agencies and the Financial Crisis Hearings] (statement of Henry Waxman), available at https://house.resource. org/i1o/org.c-span.281924-l.pdf ("Millions of investors rely on [CRAs] for independent, objective assessments. The rating agencies broke this bond of trust"). SArner et. al., supra note 8, at 370; Rousseau, supra note 93, at 622. See, e.g., Richard L. Kuersteiner, James 0. Johnston, Richard L. Wynne & Lance Miller, Your Bond Issuer Has Filed for Bankruptcy? A Survey of the Trips, Traps, and Opportunities that Await Corporate Bondholders in a Chapter n Case, 2oo8 NORTON ANN. SuRv. BANKR. L. 6 (2oo8) ("A bond represents the debtor's promise to repay borrowed money over a specified period of time at a specified rate of interest."). The Indian Anomaly: Rethinking Credit Rating Agency Regulation 13 money,' 1 in order to decide: i) whether to buy financial products from particular issuers, and 2) how much interest to charge the issuers, in order to protect themselves against possible loss. The CRAs carried out a quasi-regulatory role, ensuring the stability of the markets by promoting responsible behavior among issuers.' 2 The agencies rewarded issuers that managed their risks with high ratings, which made their financial products more marketable. 03 The agencies also increased the availability of credit for the issuers by providing accurate information to investors.' 4 In theory, the information enabled the investors to charge lower interest rates.'0 ' If they trusted the ratings, then they did not need to add large margins of error, in order to cushion themselves against unexpected losses.0 6 The lower interest rates made credit cheaper.' 7 Charging issuers to be rated earned profits for the CRAs, '0s provided information to investors, and enabled issuers to sell their products,'" but it ol The Genesis of the Current Economic Crisis Hearings, supra note 22, at 18 (statement of Eric Stein) ("Investors - the world financial markets - trusted the rating agencies because of their long history"). "'2 Frank Partnoy, Rethinking Regulation of Credit Rating Agencies: An Institutional Investor Perspective, COUNCIL OF INSTITUTIONAL INVESTORS WHITE PAPER, Apr. 2oo9 at 3 (Univ. of San Diego Sch. of Law, Research Paper no. 09-014) ("[Rlating agencies wield immense, quasi-governmental power."); Essentially, the agencies intermediated between the issuers and investors, (see Arner et aL., supra note 8, at 363); Economists have assumed that investors would not have gathered enough information on their own to inform themselves about the financial position of the issuers, (see BASEL COMMITTEE ON BANKING SUPERVISION, CREDIT RATINGS AND COMPLEMENTARY SOURCES OF CREDIT QUALITY INFORMATION, July 2ooo at 11, [hereinafter Basel Committee on Banking Supervision] available at http://www.bis.org/publ/bcbs72a.pdf); The investors would have had to fund the full cost of an investigation, but they would not have received the full benefits. Other people could have accessed the information that they uncovered without having to pay for it. Economists have referred to the information on the issuers' risk of default as a "public good," because of the difficulty of preventing others from sharing in it, (see Rousseau, supra note 93, at 623). CRAs have also been described at correcting "information asymmetries," (see, e.g., Arner et al., supra note 8, at 363). 103 Steven Schwarcz, Disintermediating Avarice: A Legal Framework For Commercially Sustainable Microfinance, 2011 U. ILL. L. REV. 1165, 1195 (2011) '04 Arner et al., supra note 8, at 363; Basel Committee on Banking Supervision, supra note 102, at i. "05 Arner et al., supra note 8, at 370. o6 Id. 107 Id. Because the CRAs provided the service of investigating issuers when no one else would have undertaken it, economists have described them as correcting a "market failure," (see Basel Committee on Banking Supervision, supra note 102, at ii). The specialization and expertise of the agencies enabled them to collect the information at a lower cost. Economists have referred to their cost advantages as "economies of scale," (see Rousseau, supra note 93, at 623; Coffee, supra note 91, at 54). ,o8 See infra text accompanying notes 109-113. 14 Columbia Journal ofAsian Law, Vol. 27, No. 1 (2013) also introduced conflicts of interest. ' The agencies charged the issuers for their ratings, and then disseminated their assessments to the public for free."' The three dominant agencies in the West, Standard & Poor's, Moody's Investors Service and Fitch Ratings, have depended on issuers for roughly ninety percent of their revenues."2 "Clearly the rating agencies skewed their assessments to please their clients," Paul Krugman wrote in the New York Times in 2010."3 Others have shared Krugman's concern. "4 In the wake of the crisis, evidence of inaccurate ratings emerged. Regulators in the United States and in Europe sought to remedy the conflicts, stressing that investor confidence in the financial markets depended on their belief in the accuracy of the ratings."' B. Egregious Behavior: "Market Share, Market Share, Market Share"116 "[A] rating, which is supposed to be an honest, objective, independent assessment of the likelihood of an investment paying off ... is not performing that function when you have this kind of pressure on people to rate a certain way in terms of their own pay," Senator Carl Levin said in April zolO, in the opening statement of a Senate Subcommittee investigation of the financial ,o9 See supra text accompanying notes 102-107. o See infra text accompanying notes 111-113. ' SECURITIES EXCHANGE COMMISSION, 2011 SUMMARY REPORT OF COMMISSION STAFF'S EXAMINATIONS OF EACH NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION, (2011), available at http:// www.sec.gov/news/studies/zof/2ounrsrosectiona5e_ examinationssummary_ report.pdf ("Of the ten registered NRSROs, seven-including the three larger NRSROs-operate predominantly under the issuer-pay model."); Lynn Bai, On Regulating Conflict of Interests in the Credit Rating Industry, 13 N.Y.U. J. LEGIS. & PUB. 253, 295 (2010) (explaining that CRAs generally provide the information to the public "free of charge"). ,,2 Arner et al., supra 8, at 373. "3Paul Krugman, Berating the Raters, N.Y. TIMES, Apr. 26, 2010, at A23, available at http://www.nytimes.com/2olo/o4/26/opinion/z6krugman.html?dbk. "14 See, e.g., Joseph E. Stiglitz, Capitalist Fools, VANITY FAIR, Jan. 2009. 15 THE PRESIDENT'S WORKING GROUP ON FINANCIAL MARKETS, POLICY STATEMENT ON MARKET DEVELOPMENTS, supra note 97, at 2, 4, 14-15; European Union Committee, House of Lords, supra note 11, at 17 ("DG Markt explained that the regulation of rating agencies is a necessary reaction to their 'massive failures' revealed by the financial crisis. They described the conflicts of interest created when the issuers of a securitised bond pays for a rating, rather than the investor."). u6 Wall Street and the Financial Crisis: The Role of Credit Rating Agencies: Hearing before Permanent Subcomm. on Investigations of the S. Comm. on Homeland Sec. and Governmental Affairs, inth Cong. 32 (2010) [hereinafter Wall Street and the Financial Crisis Hearings] (statement of Sen. Carl Levin), available at http://www.gpo.gov/fdsys/pkg/CHRG-iiashrg57321/html/CHRG-nlshrg57321.htm. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 15 crisis."7 The testimony that followed, along with information uncovered by the Securities and Exchange Commission ("SEC"), the European Commission, and the British House of Lords, depicted an industry whose actions had jeopardized the stability of the global economy."8 This part examines the evidence that the agencies inflated ratings to increase their profits. 1. Senate Subcommittee Investigation Evidence presented at the Senate investigation revealed deliberate inaccuracies in ratings."9 "Sold some more crap to Pursuit," an analyst at the investment bank UBS wrote in an internal email, in reference to securities that had earned a high, "investment-grade" rating.'20 "Version 6.o [of the ratings model] could've been released months ago and resources assigned elsewhere if we didn't have to massage the sub-prime and Alt-A numbers to preserve market share," an analyst at Standard & Poor's wrote in another.'' Clients had appeared to assume that they could demand higher ratings, either by purchasing them outright or by providing the agencies with false information. '2 An investment banker at Merrill Lynch implied that he expected higher fees to buy more favorable ratings: "We are okay with the revised fee ... under the assumption that this will not be a precedent for any future deals and that you will work with us further on this transaction to try and get to some middle ground with respect to the ratings," he said in an email to an analyst at Moody's. '23 An analyst at Standard & Poor's appeared to indicate that the agency had agreed to rate fake data:' 4 "[Tihe 25 ish assets that they included in our closing date portfolio that were dummies were replaced in less than twenty-four hours with assets that would have been notched and made the portfolio worse," he wrote.'2 5 17Id. 18 See infra Part II.B.1- 3 . 9 See infra text accompanying notes 120-21. 120 Wall Street and the Financial Crisis Hearings, supra note 116 (internal quotation marks omitted); See Schwarcz, supra note 103 ("The higher the rating, the lower the rating agency has assessed the credit risk."). "' Wall Street and the Financial Crisis Hearings, supra note 6 (internal quotation marks omitted). 2 See infra text accompanying notes 123-25. '2 Wall Street and the Financial Crisis Hearings, supra note 116 (internal quotation marks omitted). '24 See id. ("The documents show how investment bankers argued with the credit rating analysts, substituted worse assets at the last minute, and pressured analysts to waive their procedures and standards."). 12 5 Id. Columbia Journal ofAsian Law, Vol. 27, No. 1 (2013) The agencies' compensation structures encouraged the analysts to acquiesce.)6 "[Mlost employees owned either a lot of options or restricted stock in the company, as well as the profitability of the group did influence the size of the bonus, yes," the former head of the structured products group at Moody's, Eric Kolchinsky, testified. 127 Moreover, the importance of maintaining revenues appeared to increase over time. 128 A former vice president and senior credit officer at Moody's, Richard Michalek, described "a revision . . .where a larger percentage of our compensation [depended on] whether or not we were reaching our revenue numbers on a quarterly and annual basis which would allow us to, maximize our - or max out our bonuses."2 9 The Senate testimony seemed to demonstrate that the CRAs continued to boost their ratings in order to preserve market share, even in the midst of the crisis. 3 "Despite the ... market implosion we were witnessing, it appeared to me that my manager was more concerned about losing a few points of market share than about violating the law," the former Moody's executive, Eric Kolchinsky, said.'3' He elaborated: Managers of rating groups were expected by their supervisors to build, or at least maintain, market share. It was an unspoken understanding that loss of market share would cause a manager to lose his or her job.. . Senior management would periodically distribute emails detailing their departments' market share . . . Colleagues have described enormous pressure when their market shares dipped.'32 2. Securities and Exchange Commission Staff Examinations The information that emerged in the Senate tracked the findings of an SEC examination of selected CRAs.'3 The SEC investigation suggested that t26 See infra text accompanying notes 127-29. 127 Wall Street and the Financial Crisis Hearings, supra note u6 (statement of Eric Kolchinsky). 128 See id. (statement of Richard Michalek). 29 Id. (internal quotation marks omitted). 130 See infra text accompanying notes 131-32. '3' Wall Street and the Financial Crisis Hearings, supra note n6 (statement of Eric Kolchinsky). 1 32 Id. 133 See infra text accompanying notes 134-41. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 17 analysts at the agencies knew about revenues and raised their ratings in order to increase them.'3 The SEC had observed that analysts at the CRAs participated in fee negotiations and allowed the discussions to influence the ratings that they assigned. '3 "Analysts appeared to be aware, when rating an issuer," the Commission report stated, "of the ratings agency's business interest in securing the rating of the deal."'136 Clients that pressed for higher ratings "could influence the rating agencies' decisions on whether to update a model when such an update would lead to a less favorable outcome," the report continued. 37 The SEC based its findings on internal emails that emphasized the pressure to sacrifice accuracy in order to maintain profits.' 8 "[W]e are meeting with your group this week to discuss adjusting criteria for rating CDOs of real estate assets ... because of the ongoing threat of losing deals," one internal email said.' 39 "[Aispects of the firm's ratings methodology w[ill] have to be revisited to recapture market share from the competing rating agency," stated another.' "[L]et's hope we are all wealthy and retired by the time this house of cards falters," an analyst responded. 4 ' 3. European Studies Evidence that conflicts of interest from the "issuer-pays" model produced inaccurate ratings also surfaced in Europe.'42 A 2008 survey discussed in the European Commission indicated that eleven percent of the members of a professional society of financial analysts, the Chartered Financial Analysts Institute, had "witnessed a CRA changing a rating as consequence of pressure or influence from an investor, issuer or underwriter.' 43 Members of the British 134 SEC. & EXCH. COMM'N, SUMMARY REPORT OF ISSUES IDENTIFIED IN THE COMMISSION STAFF'S EXAMINATIONS OF SELECT CREDIT RATING AGENCIES, at 25 (July 2oo8), available at http://www.sec.gov/news/studies/2oo8/craexaminationo7o8o8.pdf ("Rating agencies do not appear to take steps to prevent considerations of market share and other business interests from the possibility that they could influence ratings or ratings criteria."). 131 See infra text accompanying notes 136-37. 136 SECURITIES AND EXCHANGE COMMISSION, supra note 134, at 25. 137 Id. at 32. 38 See infra text accompanying notes 139-41. 39 SECURITIES AND EXCHANGE COMMISSION, supra note 134 (footnote omitted) (internal quotation marks omitted). 1 40 Id. '4' Id. at 12 n.8; See, e.g., Dallas, supra note 23, at 265, 340. 42 See infra text accompanying notes 143-45. 43 See McVea, supra note 21, at 701, 713. 18 Columbia journal of Asian Law, Vol. 27, No. 1 (2013) House of Lords described "miscalculation" of risks because of "flaws in the methodologies of rating agencies" at a 2oo8 hearing.'" The problems had been "exacerbated by conflicts of interests caused by the originator ... purchasing the rating," they concluded. 4 C. Getting Here: "How Can You Miss So Badly" 146 Conflicts of interest did not always compromise the CRAs.' 47 This part describes the agencies' shift from charging investors to charging issuers and the power that they gained in the absence of strict regulation.,48 It then explains how the introduction of securitized financial products intensified their conflicts of interest.'4 9 The new products produced three changes: they offered the agencies higher profits'50 and less need for accuracy,' 5' as well as fewer potential clients over whom to compete. 152 1. Adopting "Issuer Pays" Without New Regulation Changes in technology, coupled with the rising influence of the CRAs, triggered the shift to the "issuer-pays" model.' 53 At the turn of the century, investors paid the CRAs.'54 Cheap photocopying began to enable them to 144 European Union Committee, House of Lords, supra note 11, at 8. 45 Id. 146 Wall Street and the Financial Crisis Hearings, supra note 116 (statement of Senator Kaufman). 147 See Rousseau, supra note 93, at 634. 148 See infra Part II.C.1-2. 149 See John C. Coffee, Ratings Reform: The Good, The Bad, and The Ugly, 1 HARV. Bus. L. REv. 231, 236 (2011) ("[Tjhe conflicts were stronger and the prospects for ratings arbitrage greater in the case of structured finance."). 150 See Dallas, supra note 23, at 289, 340. 151 See Credit Rating Agencies and the Financial Crisis Hearings, supra note 98, (statement of Henry Waxman) ("These new financial inventions were so complex that virtually no one really understood them."). 152 See Hill, supra note 9, at 13, 16 (2012) (describing "close relational ties"). 153 See infra text accompanying notes 154-57. '4See D. Andrew Hatchett, Sox It To 'Em: Using Sarbanes-Oxley As A Model For Regulating Conflicts Of Interest In The Credit Rating Industry, 63 ALA. L. REV. 407, 425 (2012). Moody's first graded railroad bonds and the information increased the number of people that bought them. See Partnoy, supra note 102. By the 192os, Moody's charged investors for ratings of most of the bond market. See Sinclair, supra note 13, at 4. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 19 access the ratings for free.'55 The default of the railroad company Penn Central motivated issuers to seek ratings from the agencies, in order to reassure potential investors of their solvency." 6 The agencies then began to charge the issuers. 15 7 A small group of CRAs gained power but remained free of direct regulation. ' 8 In 1975, the SEC recognized the existing agencies, as official Nationally Recognized Statistical Rating Organizations ("NRSROs").' 59 The new status restricted entrance to the industry. '60 In 2001, the agencies maintained high ratings for financial products issued by Enron, even though they had identified weaknesses in the company's financial statements . 6'They lowered their ratings only four days before Enron entered bankruptcy. 62 The SEC imposed no new rules in response to the Senate's call for "meaningful SEC oversight," 63 though it predicted that the "issuer-pays" model would cause the agencies to "rate issuers more liberally and temper their diligence .. .. "',64 In 20o6, Congress reversed course and barred the SEC from regulating "the substance of the credit ratings or the procedures and methodologies" that the agencies used.' 6, 155 See Statement on Reforming the Role of the Statistical Ratings Organizations in the Securitization Process, FINANCIAL ECONOMISTS ROUNDTABLE (The Wharton School, Philadelphia, PA), Dec. 2oo8, at 4, available at http://fic.wharton.upenn.edu/ fic/policyYo2opage/FER12%2o%20oo8rev.pdf. 56 See Rousseau, supra note 93; See Amer et al., supra note 8, at 361, 373 (2010). 157 See Darbellay & Portnoy, supra note 11. 8 See Arner et al., supra note 8, at 363. 159 See Hill, supra note 9. i6o See Arner et al., supra note 8, at 372; See FINANCIAL ECONOMISTS ROUNDTABLE, supra note 155, at 6 ("From 1975 to zooz, although the SEC received numerous applications from entities in the United States and abroad, only one new general purpose NRSRO was approved."). See FINANCIAL ECONOMISTS ROUNDTABLE, supra note 155, at 4, for the argument that barriers to entry existed even before the SEC established the NRSRO designation. 161 Hatchett, supra note 154, at 407-08, 416. 162 See Hill, supra note 9, at 13. '6 ' See Credit Rating Agencies and the Financial Crisis Hearings, supra note 98, at 4. '64 Hatchett, supra note 154, at 418-19 (quoting U.S. SEC. & EXCH. COMM'N, REPORT ON THE ROLE AND FUNCTION OF CREDIT RATING AGENCIES IN THE OPERATION OF SECURITIES MARKETS: AS REQUIRED BY SECTION 702(B) OF THE SARBANES OXLEY ACT OF 20OZ (2003) (internal quotation marks omitted)). ,61 The Rating Agency Reform Act, enacted on Sept. 29, 2006 created a new Section 15E of the Securities Exchange Act of 1934 and provided for some new authority of the SEC, while also explicitly limiting it. See, e.g., SECURITIES AND EXCHANGE COMMISSION, supra note 134, at 4. To the extent that it addressed conflicts of interest, the new Act simply required the agencies to institute written codes of conduct to manage them. See, e.g., Hatchett, supra note 154, at 418 (quoting 15 U.S.C. § 78o-7(h)(1) (2012)). 20 Columbia Journal of Asian Law, Vol. 27, No. 1 (2013) The CRAs also encountered limited regulation outside of the United States.' 66 The Enron scandal prompted foreign officials to review their policies, but they decided to continue their reliance on self-regulation. 167 The International Organization of Securities Commissions ("IOSCO") drafted a voluntary code of conduct without a mechanism for enforcement.' 8 In 2006, the Committee of European Securities Regulators ("CESR") advised the European Commission to adopt a "wait and see" approach to regulating the agencies.'" The CESR monitored compliance with IOSCO's code of conduct and reported its findings annually to the Commission.' 7°The Commission supported the rights of companies to deviate from the code, so long as they disclosed it. ' 7' 2. Securitization and Increased Competition The advent of securitization seemed to exacerbate the conflicts of interest that the "issuer-pays" model produced.' 72 The term "securitization" refers to the process by which rights to future loan repayments were: i) separated from the risk that the borrowers might not pay; z) grouped together; and 3) sold to other investors in portions, or "tranches.' 73 Investment banks, the "issuers," pooled the rights to repayment and divided them according to the underlying risk that the borrowers would default. 7 4 The issuers paid the CRAs for ratings when each tranche sold,' 7 which encouraged the agencies to inflate scores to make them more marketable.' 6 In 2oo8, 64,000 separate tranches of securitized debt earned triple-A ratings, 166 See infra text accompanying notes 167-71. 67 See Amadou, supra note 7, at 7. 168 Int'l Org. of Sec. Comm'ns, IOSCO Statement of Principles Regarding the Activities of Credit Rating Agencies (Sept. 25, 2003), http://www.fsa.go.jp/inter/ios/2oo3o93o/ o2.pdf; see Arner et al., supra note 8, at 369-70. 169 See Amer et al., supra note 8, at 368-69. 170 See Coffee, supra note 149, at 249. '71 See id. 172 See infra text accompanying notes 173-96. 173 See Steven Schwarcz, The 2on Diane Sanger Memorial Lecture Protecting Investors In Securitization Transactions: Does Dodd-Frank Help, Or Hurt?, 72 LA. L. REV. 591, 594 (2012); See Int'l Org. of Sec. Comm'ns, Code of Conduct Fundamentals-for Credit Rating Agencies, at 4 (May 2oo8), available at http://www.iosco.org/library/pubdocs/ pdf/IOSCOPD27o.pdf. 174 See The Genesis of the Current Economic Crisis Hearings, supra note 22, at 29, 30. 175 See id. at 29. '76 See Wall Street and the Financial Crisis Hearings, supra note ii6 (statement of Raymond McDaniel); Schwarcz, supra note 1O3, at 1195. The Indian Anomaly: Rethinking Credit Rating Agency Regulation z1 compared to only twelve companies worldwide.'77 The issuers re-pooled riskier tranches with additional assets, then sought higher ratings for the new combinations.178 Because the CRAs charged more to rate the securitized products than they could for traditional debt, the importance of retaining clients increased.' 79 Agencies could earn more than $200,000 for complex ratings. 'l ° Moody's graded 9,029 mortgage-backed securities triple-A, the equivalent of 30 products per day, while awarding the same score to only four traditional issuers. 's1 Within seven years, Moody's profits increased four-fold, and its stock price rose 6oo% 1 82 It had the highest net revenues of any company listed on one index of publicly-traded businesses for five consecutive years.'8 3 The source of the new revenues concentrated among only a few issuers, which increased their leverage over the CRAs.'8S Twelve issuers controlled nearly eighty percent of the market, and six accounted for half of it.'8 The complexity of the products made ratings more variable,'86 and the issuers appeared to shop among agencies for the highest grades.'8s 177 Lloyd C Blankfein, Remarks By Lloyd C. Blankfein To The Council Of Institutional Investors, GOLDMAN SACHS (Apr. 7, 2009), http://www.goldmansachs.com/media- relations/in-the-news/archive/lcb-cii-remarks.html. 78 See The Genesis of the Current Economic Crisis Hearings, supra note 22, at 17. 179 See FINANCIAL ECONOMISTS ROUNDTABLE, supra note 155, at 5. ,so See The Genesis of the Current Economic Crisis Hearings, supra note 22, at 18. 181 See Phil Angelides, Opening Remarks of Chairman Phil Angelides at the Financial Crisis Inquiry Commission Hearing on the Credibility of Credit Ratings, the Investment Decisions Made Based on Those Ratings, and the Financial Crisis, Financial Crisis Inquiry Commission, at i, (June 2, 2010), http://fcic-static.law.stanford.edu/ cdnmedia/fcic-testimony/2o0o-o6o2-Angelides.pdf. 182 See Credit Rating Agencies and the Financial Crisis Hearings, supra note 98, at 2; id. '83 See Credit Rating Agencies and the Financial Crisis Hearings, supra note 98. 184 SECURITIES AND EXCHANGE COMMISSION, supra note 134, at 32 ("The combination of the arrangers' influence in determining the choice of rating agencies and the high concentration of arrangers with this influence appear to have heightened the inherent conflicts of interest that exist in the issuer pays" compensation model."). 185 See Coffee, supra note 149, at 238; See also SECURITIES AND EXCHANGE COMMISSION, supra note 134, at 38. 186 See Adam J. Levitin & Susan M. Wachter, Explaining The Housing Bubble, ioo GEO. L.J. 1177, 1236-37 (2012). 187 See Credit Rating Agencies and the Financial Crisis Hearings, supra note 98, at 21 (testimony of Jerome Fons); See European Union Committee, House of Lords, supra note n, at 17 ("[E] ncouraging the issuer to go 'from ofie [rating agency] to another until they got the rating for the securitised product they wanted."'); See Dallas, supra note 23, at 289-9 ° . Columbia Journal of Asian Law, Vol. 27, No. i (2o13) The complexity of the products also made inaccurate ratings seem easier to conceal, and the CRAs stopped updating scores.'8 While public financial disclosures provided a test of the quality of traditional bond ratings, the new products had no comparable performance records. '8 Since revenues determined bonuses,'90 and legal immunity protected analysts from liability, 91 the agencies left in place models that underestimated risks.'92 The CRAs waited more than a year to revise their ratings to reflect disturbances in the mortgage markets.' 93 Though the agencies warned of problems in 2oo6, they continued to award triple-A ratings to mortgage- backed securities.' 94 Eventually, Moody's downgraded eighty three percent of its triple-A scores during a six-month period,' 9 and Standard & Poor's lowered more than two-thirds of its investment-grade ratings.' 96 See, e.g., SECURITIES AND EXCHANGE COMMISSION, supra note 134, at 32. l See Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience, supra note 94, at 33; See Turmoil in U.S. Credit Markets: The Role of the Credit Rating Agencies: Hearing Before S. Comm. on Banking, Housing, and Urban Affairs, noth Cong., 2nd Sess. 32 (2oo8) (testimony of John C. Coffee) [hereinafter The Role of Credit Rating Agencies Hearings - Coffee] available at http://www.banking. senate.gov/public/-files/OpgStmtCoffeeSenateTestimonyTurmoilintheUSCreditMarkets. pdf; See SECURITIES AND EXCHANGE COMMISSION, supra note 134. '9 See The Genesis of the Current Economic Crisis Hearings, supra note 22, at 17. 19 Judicial opinions have found ratings to be "opinions" protected by the First Amendment. See, e.g. Jefferson Cnty. Sch. Dist. No. R-j v. Moody's Investor's Sen's. Inc., 175 F. 3d 848, 852-56 (ioth Cir. 1999); In re Enron Corp. Sec. Derivative & "ERISA" Litigation, 511 F. Supp. 2d 742, 752 (S.D. Tex. 2005). The high pleading standards imposed by the Private Securities Litigation Reform Act of 1995 have also protected the CRAs from responsibility. See The Role of Credit Rating Agencies Hearings - Coffee, supra note 189, at 1-2. 192 See The Role of Credit Rating Agencies Hearings - Coffee, supra note 189, at 1-2. See, e.g., SECURITIES AND EXCHANGE COMMISSION, supra note 134, at z6 ("Another rating agency reported to the Staff that one of its foreign ratings surveillance committees had knowledge that the rating agency had issued ratings on almost a dozen securities using a model that contained an error."); Wall Street and the Financial Crisis Hearings, supra note n6 (statement of Frank Raiter) ("[Tihe order came to start doing impact analysis on the effectiveness new models had on market share."); Darbellay & Portnoy, supra note 11, at 3. '93 See Credit Rating Agencies and the Financial Crisis, supra note 98 (testimony of Jerome S. Fons). '94 See Jules Stewart, Subprime to the Ridiculous, FINANCIAL DIRECTOR (Sept. 24 2007), http://www.financialdirector.co.uk/financial-director/analysis/1744125/sub-prime- ridiculous. 195 See Darbellay & Portnoy, supra note ii, at 2. '96 See Credit Rating Agencies and the Financial Crisis, supra note 98, at 2. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 23 D. Blaming the CRAs: "A Watchdog Paid By the Persons They Are to Watch"' 97 Blame for the recent financial crisis crystallized around the CRAs' "issuer- pays" model,' 8 and not their role as financial "gatekeepers."'9 9 "There has got to be a way that the regulators are going to find to eliminate this conflict of interest," Senator Levin said when he opened the Senate investigation of the crisis." Europe and the United States supported regulations for neutralizing the conflicts, while leaving the agencies' function unchanged.2"' The EU reversed its earlier decision to rely on self-regulation and drafted new mandatory rules.20 2 "CRAs will have to comply with exacting regulatory requirements to make sure ratings are not tainted by the conflicts of interest inherent to the ratings business," European Commissioner Charles McCreevey said.203 "The crisis has shown that self-regulation has not worked."0 4 The legislation established a European authority over the agencies20 5 and imposed several requirements.2 °6 Registered agencies must now publicize their conflicts of interest and demonstrate that they have not affected ratings.20 7 Analysts may not participate in fee negotiations'08 or earn income based on revenues." ° The analysts must also rotate responsibility within their agencies for rating 210individual issuers. 197 The Role of Credit Rating Agencies Hearings - Coffee, supra note 189, at 2. 198 See Mary Schapiro, Chairman, SEC, Address to Practising Law Institute's "SEC Speaks in 2009" Program (Feb. 6, 2009), available at http://www.sec.gov/ news/speech/2oo9/spcho2o6o9mls.htm ("I hope to pursue as priorities: Improving the quality of credit ratings by addressing the inherent conflicts of interest credit rating agencies face as a result of their compensation models ..... '1 See Sinclair, supra note 13, at 4. 21 Wall Street and the Financial Crisis Hearings, supra note ni6. 2o See infra text accompanying notes 202-18. 202 See Arner et al., supra note 8, at 379. 203 See Consultation by the Commission Services on Credit Rating Agencies, supra note 91. 204 Id. 205 See Regulation of the European Parliament and of the Council on Credit Rating Agencies (EC) No. 1o6o/2009 of 16 Sept. 2009; see Regulation of the European Parliament and of the Council (EU) No. 513/2011 of 11 May 2011 (amending Regulation (EC) No. 1060/2009 on credit rating agencies); see McVea, supra note 21, at 73o. 2o6 See McVea, supra note 21, at 724. 207 Id. 208 Id. at 726. 209 Id. 210 id. Columbia Journal of Asian Law, Vol. 27, No. 1 (2o13) U.S. regulators restricted similar behaviors and tried, but failed, to abolish the "issuer-pays" model.2"' The new SEC Rule 17g-5 opened the ratings process to greater public scrutiny and restricted analysts from a range of conflicts- producing activities." 2 The Dodd-Frank Act,2"3 a package of reforms drafted in response to the crisis, nearly included plans for a Credit Agency Review Board." 4 The Board would have selected agencies to rate individual products and would have limited their fees to "reasonable" amounts."' The proposal passed the Senate by a large majority but lost in the House.216 The final legislation compromised by calling for the SEC to study the issue.2 '7 The compromise "amounts to rearranging the deck chairs on the Titanic, while ignoring the gaping hole created by the iceberg," one law school professor remarked. 28 Could blaming the conflicts of interest, however, have diverted the regulators from addressing the more fundamental problem of their reliance on the CRAs as quasi-financial regulators?"9 III. COUNTER-NARRATIVE: HYMAN MINSKY AND THE ENDOGENEITY OF CRISES In 2007, a member of the British Parliament that had worked as an economist at a CRA downplayed the conflicts of interest of the agencies. 22 0 "The real problem," he said in an interview, was not the conflicts of interest but the fact that "financial markets fall in love. They fall in love with new things, with innovations, and . . . it is very difficult to assess [their] real riskiness. 2' The statement sounded like an endorsement of the theories of the late economist Hyman Minsky. 2,. See infra text accompanying notes 211-17. 212 See Hill, supra note 9, at 18. 213 12 U.S.C. §§ 1465-5641; 15 U.S.C. §§ 77z-2a-8344; See generally Leonard Street and Deinard, Making Sense of Dodd-Frank (2010), http://dodd-frank.com. 214 See Hatchett, supra note 154, at 425-26. 215 See Coffee, supra note 149, at 256. 216 See, e.g., Congress Drops Changes for Credit-Rating Agencies, NEW YORK TIMES DEALBOOK (June 16, 2010), available at http://dealbook.nytimes.com/2oio/o6/16/ congress-drops-changes-for-credit-rating-agencies/?r=o; See Hill, supra note 9, at 19. 27 See Dallas, supra note 23, at 341. 218 See Coffee, supra note 149, at 58. 219 See, e.g., Partnoy, supra note 154, at 3 ("[T]hese three agencies wield immense, quasi- governmental power."). 220 CHARLES J. WHALEN, THE LEVY ECON. INST. OF BARD COLLEGE, PUB. POLICY BRIEF No. 92, THE U.S. CREDIT CRUNCH OF 2007: A MINSKY, MOMENT, 2007 AT 15. 221 Id. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 25 Minsky's ideas about the causes of financial crises did not attract attention before he died in 1996.222 His views paralleled those of John Maynard Keynes, in advocating for government intervention in financial markets.223 Minsky, however, emphasized a sequence of events that he called the "financial instability hypothesis." 24 He believed that episodes of "euphoria" inevitably followed periods of stability. 225 The "euphoria" caused companies and consumers to acquire increasing amounts of debt.226 Over time they relied on more speculative financial instruments, until the economy became so fragile that it collapsed. 22 To prevent the collapse, Minsky wrote, public institutions needed to restrict "pro-cyclical behavior" - the volatile behavior that increased naturally with economic growth.2s In the wake of the most recent crisis, Minsky's writings have resurfaced, and his financial stability hypothesis has gained notice. 22 ' This section proposes that Minsky would have found the new restrictions on the CRAs too simplistic because they left responsibility for regulating financial markets in the hands of private "gatekeepers. ' 23 ' The section first explains his theories and endeavors to predict his interpretation of the recent crisis. It then seeks to formulate an alternate response that he would have supported. 222 See, e.g., Jos6 Gabilondo, Dodd-Frank, Liability Structure, And Financial Instability Cycles: Neither A (Ponzi) Borrower Nor A Lender Be, 46 WAKE FOREST L. REV. 469, 470 (2011). 123 See, e.g., Michael Syron Lawler, Minsky and Keynes on Speculation and Finance, 27 SOc. Sci J. 435, 439 & 445 (199o) (discussing the Keynes and Minsky's views on the necessity of intervention). 224 See generally, Hyman Minsky, The Financial Instability Hypothesis (The Levy Econ. Inst. of Bard College, Working Paper No. 74, 1992). 225 See, e.g., The Fed Discovers Hyman Minsky, THE ECONOMIST, Jan. 7, 2010. 226 See, e.g., Jeffrey N. Gordon & Christopher Muller, Confronting Financial Crisis: Dodd- Frank's Dangers And The Case For A Systemic Emergency Insurance Fund, 28 YALE J. ON REG. 151, 171 (2011). 227 See, e.g., Id. 228 Hyman Minsky & Piero Ferri. Market Processes and Thwarting Systems (The Levy Econ. Inst. of Bard College, Working Paper No. 64, 1991) at 4 ("institutions and interventions thwart the instability breeding dynamics that are natural to market economies by interrupting the endogenous process"). 229 See, e.g., WHALEN, supra note 220, at 17. 230 Rousseau, supra note 93, at 627. ("CRAs wield influential power over both issuers and investors."). 26 Columbia Journal of Asian Law, Vol. 27, No. 1 (2o13) A. Minsky's Theories: The Economy "Generates a Financial Structure Susceptible to Financial Crises"2 31 Minsky theorized that economic crises resulted from volatility that was intrinsic to financial markets. 3" He viewed public regulation as necessary to contain the markets' susceptibility to bouts of speculation. 33 In the absence of robust regulation, he believed, collapse would punctuate finite periods of economic stability.2 " The chain of events that he described began with excessive borrowing. 35 Stability would breed its own destruction by encouraging too much risk- taking.236 Specifically, he predicted that profitable companies would seek new loans in order to grow.2 37 Initially, the investments would increase the profits that they earned.3 8 Next, Minsky expected that reports of the profits would fuel more widespread participation. 39 Additional companies would demand loans. 4 While the expansionary period lasted, the companies with the highest leverage would reap the biggest rewards.' Subsequently, Minsky predicted, the political system would adapt to validate the behavior. 4 Profitable borrowers would donate to sympathetic politicians, or engage lobbyists to promote their interests.1 3 The public would 23! Hyman Minsky, The Financial Instability Hypothesis: An Interpretation of Keynes and an Alternative to 'Standard' Theory, CHALLENGE MAGAZINE, Mar.-Apr. 1977, at 25. 232 See, e.g., Lahart, supra note 15. 233 See, e.g., Minsky & Ferri, supra note 228, at 4. ("in a world where the internal dynamics imply instability, a semblance of stability can be achieved or sustained by introducing conventions, constraints, and interventions into the environment."). 234 See, e.g., Jan Kregel, Regulating The Financial System In A Minskyian Perspective, remarks prepared for the conference "Financial Stability and Growth," Phase 3 of the Ford Foundation project: "Growth with Financial Stability and New Developmentalism" organised by the Centre for Structuralist Development Macroeconomics of the Sso Paulo School of Economics of Getulio Vargas Foundation, SAo Paulo, Mar. 22-23, 2012 at i, available at http://cemacro.fgv.br/sites/cemacro.fgv.br/files/Panel%2o4%2o-%2oJan %2oKregel o.pdf. 235 See, e.g., Dallas, supra note 23, at 294. 236 See, e.g., Lahart, supra note 15. 237 See, e.g. Victor A. Beker, Rethinking Macroeconomics In The Light Of The Financial Crisis, Oct. 20, 2o at 7, available at http://ssrn.com/abstract=1946867. 238 See, e.g., Id. '39 See, e.g., Lawler, supra note 223, at 439, 445. 240 See, e.g., Id. ' See, e.g., Dallas, supra note 23, at 294. S25ee, e.g., Gordon & Muller, supra note 226, at 178. 243 Id. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 27 interpret profitability as evidence of expertise and vote for deregulation.' As support for growth permeated the public discourse, few would question the instability that was building. 4 5 In the following stage, the economy would grow more fragile as a rising "euphoria"' 6 drove more companies and households to borrow. 4 7 Banks and other financial intermediaries would create speculative financial products in order to satisfy the demand. 8 "The introduction of additional layering of finance, together with the invention of new instruments.., is evidence.., of the increased fragility of the system," Minsky wrote. 9 Eventually, the amount of outstanding debt would push the system towards collapse. Those intent on maximizing their leverage would not save enough money to repay the loans.25 "A reduction in the margins of safety means that much more debt than before can be carried by an expected cash flow," Minsky explained. 1 The companies and households would raise money to cover payments due on their debts through additional borrowing. 52 They would "increase [their] outstanding debt in order to meet [their] financial obligations," he wrote. 253 In the end, the sequence of meeting obligations with new debt would break down.2 54 "After an initial interval, the basic disequalibrating tendencies of capitalist finance will once again push the financial structure to the brink of fragility," Minsky wrote.255 Ultimately, it would become apparent that some of 2 Id. 24 5 d. 246 See, e.g., Hyman Minsky, STABILIZING AN UNSTABLE ECONOMY xxi (1986); Louis Uchitelle, H. P. Minsky, 77, Economist Who Decoded Lending Trends, N.Y. TIMES, Oct. 26, 1996. 247 See, e.g., Jan Kregel, The Natural Instability of Financial Markets 3 (The Ideas Working Paper Series, Working Paper No. 04/2009, 2009), available at http://www.networkideas.org/working/jun2oo9/o4_2oo 9 .pdf; See also John Cassidy, The Minsky Moment, THE NEW YORKER, Feb. 4, 2o08 ("As boom leads to euphoria, Minsky said, banks and other commercial lenders extend credit to ever more dubious borrowers, often creating new financial instruments to do the job."). 248 See, e.g., Dallas, supra note 23, at 294. 4 See Minsky, supra note 246. 250 See, e.g., Beker, supra note 237. 251 Hyman Minsky, The Evolution of Financial Institutions and the Performance of the Economy, 20 J. ECON. ISSUES 345, 350 (1986). 252 See, e.g., Beker, supra note 237. 253 Hyman Minsky, Banking and a Fragile Financial Environment, Paper prepared for the American Economics Association Meetings, Sept. 16, 1976 at 5. 24 See infra text accompanying notes 255-257. 255 Minsky, supra note 246, at 370. 28 Columbia Journal of Asian Law, Vol. 27, No. 1 (2013) the borrowers had overextended themselves. ,6 Lenders would cease offering them credit, and they would have to sell assets to raise money to pay back their outstanding loans. 257 The cycle would then progress to a crisis."'8 As more borrowers had to sell assets, too many assets would flood the market, and the oversupply would depress prices. 59 As Minsky explained, "units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.' ' 6 In time, the assets would not be worth enough to pay back the loans, and the central bank would have to decide whether to intervene on behalf of the lenders. 6' B. Predicting Minsky's Reaction to Regulating Credit Rating Agencies: "No Simple Answer to the Problems of our Capitalism" 2 62 Minsky's theories offered an alternate explanation for the crisis. 63 The "financial instability hypothesis" seemed to suggest that focusing on a discrete shortcoming of the CRAs failed to address the systemic tendency towards collapse. 64 Eliminating conflicts of interest may have achieved accuracy in ratings.265 It would not, however, prevent volatility, because it left the agencies in charge of regulating the markets.z66 This part extrapolates from his writings a possible interpretation of recent events. Viewed through the lens of Minsky's hypothesis, the CRAs did not have the capacity to prevent the crisis.267 Their failings appeared to be symptomatic 256 See, e.g., Charles J. Whalen, Rethinking Economics For A New Era Of Financial Regulation: The Political Economy Of Hyman Minsky, 15 CHAP. L. REV. 149, 154 (2os). 257 See, e.g., Id. 258 See, e.g., Lahart, supra note 15. ',9 See, e.g., Id. 26o Minsky, supra note 224 at 8. 26, See, e.g., Lahart, supra note 15. 262 Quoted in Steven Mihm, Why Capitalism Fails, BOSTON GLOBE, Sept. 13, 2009. 263 See rest of Part III.B. 264 See, e.g., Gabilondo, supra note 222, at 483 ("If we believe, as did Minsky, that capitalist market systems could be enhanced by mitigating leverage cycles, then we judge the [Dodd Frank] Act by whether it does so."). 265 See, e.g., Sinclair, supra note 13. 266 See, e.g., Zachary Gubler, Regulating In The Shadows: Systemic Moral Hazard And The Problem Of The Twenty-First Century Bank Run, 63 ALA. L. REV. 221, 26o (2012). 267 See, e.g., Kregel, supra note 18, at 2 ("The fact that the subprime crisis was able to spread to the rest of the financial system and set off a full-scale bout of systemic instability and debt deflation is, however, the result of a Minsky process of sustained and increasing financial fragility in the rest of the financial system."). The Indian Anomaly: Rethinking Credit Rating Agency Regulation 29 of deeper problems. 268 "The tendency to transform doing well into a speculative investment boom is the basic instability in a capitalist economy," he wrote.269 A period of growth that resembled the "euphoric" phase in his cycle seemed to infect the CRAs, along with the other participants in the system. 70 The agencies applied the same principles they had used to rate traditional corporate debt and graded the new products highly.27' Because the new securities did not trade on transparent markets and had no similar precursors, the agencies sustained an impression that they were worth more than their constituent parts.272 The agencies' "gatekeeping" function broke down.273 Minsky appealed to policymakers to empower market regulators that could address the causes of fragility, and to reject "exogenous" responses such as tinkering with the incentives of the CRAs. 74 "We need a theory that makes instability a normal result in our economy and gives us handles to control it," he wrote.2 75 "Unless we understand what it is that leads to economic and financial instability, we cannot ... eliminate it. ' '27 6 Minsky's conception of economic cycles bore a resemblance to the recent crisis." A period of stability seemed to generate increases in the accumulation of debt and the use of speculative financial instruments.7 8 In the early 2000s, the Federal Reserve lowered interest rates to one percent and set in motion a 268 See, e.g., Nicholas Dorn, The Governance Of Securities, 50 BRIT. J. CRIMINOLOGY 23, 30-31 (2010) ("'blaming' the ratings agencies is merited insofar as it points to a conflict of interest; however, such blaming could also function as a diversion - like blaming a servant for carrying out one's instructions. If the subprime phenomenon was driven from above (by the capital markets), then it is hardly surprising that there was immense pressure upon a gatekeeper in the connecting chain."). '69 Minsky, supra note 231, at 24. 270 See, e.g., Amadou, supra note 7 ("ratings increased systemic risk and may be pro- cyclical, helping fuel investments in 'good times'). 271 See, e.g., Kregel, supra note 247. 272 See, e.g., Anastasia Nesvetailova, The Crisis Of Invented Money: Liquidity Illusion And The Global Credit Meltdown, ii THEORETICAL INQUIRIES L. 125,144 (2010). 273 See id. at 136-37. 274 See, e.g., Minsky & Ferri., supra note 228, at 4. ("in a world where the internal dynamics imply instability, a semblance of stability can be achieved or sustained by introducing conventions, constraints, and interventions into the environment."). 275 Minsky, supra note 249, at in. 276 Id. 277 See infra text accompanying notes 278-280. 278 See, e.g., Whalen, supra note z56, at 164. 30 Columbia Journal ofAsian Law, Vol. 27, No. 1 (2013) boom in the housing market. 79 The market relied on increasingly unstable sources of credit.280 From Minsky's perspective, the cycle began as consumers acquired more debt. Low interest rates made mortgages cheaper, and more people sought loans to buy homes.2 8 As demand increased, property values rose, and the buyers had to obtain larger loans.282 "The fundamental instability of a capitalist system is upwards," Minsky wrote. 23 The expansion he predicted seemed to continue as the increase in prices made selling property more profitable. 284 Other consumers entered the housing market and sought additional loans .285 The lucrative home sales they observed appeared to justify the size of the mortgages they required. 86 Lenders worried less about the potential for default and demanded less security from borrowers.287 In 2004, for example, forty two percent of first- time home buyers paid no down payment.288 Lenders seemed to engage in risky practices free from regulatory constraints. 289 As Minsky anticipated, finance was the main driver of wealth creation, and political policies supported innovation. 9' "In a world of 279 See, e.g., Gabilondo, supra note 222, at 473-74. 28o See, e.g., Philip Arestis & Elias Karakitsos, Subprime Mortgage Market and the Current Crisis (Cambridge Centre for Economic and Public Policy, Working Paper No. 08-09, 2009) at 6. 281 See, e.g., Antony Davies & James R. Harrigan, Why the Education Bubble Will Be Worse Than the Housing Bubble, U.S. NEWS, (Jun. 12, 2012), available at http://www.usnews.com/opinion/blogs/economic-intelligence/2012/06/12/the- government-shouldnt-subsidize-higher-education. 282 See, e.g., Id. 283 Minsky, supra note 231, at 24. 284 See, e.g., Arestis & Karakitsos, supra note 280, at 6. 285 See, e.g., William Lang & Julapa Jagtiani, The Mortgage and Financial Crises: The Role of Credit Risk Management and Corporate Governance, 38 ATLANTIC ECON. J., 123, 127 (2010). 286 See, e.g., L. Randall Wray, Money Manager Capitalism and the Global Financial Crisis (Levy Econ. Inst., Working Paper No. 578, 2009) at 8-9. 287 See, e.g., Lang & Jagtiani, supra note 285, at 127-28. 288 Whalen, supra note 256, at 153. 289 See, e.g., The Genesis of the Current Economic Crisis Hearings, supra note 22, (testimony of Hon. Eugene A. Ludwig) ("The paradigm of the last decade has been the conviction that un- or under-regulated financial services sectors would produce more wealth"). 290 See, e.g., Jane Kelsey, The Conundrum Of Shifting Orthodoxies: FTAs And Korea's Currency Controls, 14 J. INT'L ECON. L. 845, 848 (2011). The Indian Anomaly: Rethinking Credit Rating Agency Regulation 31 businessmen and financial intermediaries who aggressively seek profit," he wrote, the "innovators will always outpace regulators."29 In time, the lenders realized that they could earn more money through leveraging their loans than they could in fees-from originating mortgages.29 Financial institutions began to purchase and pool the mortgages, then sell individual tranches to downstream investors. 9 3 "Innovations in financial practice are a feature of our economy," Minsky wrote. 94 The growing demand for new mortgages to securitize increased instability in the economy. 95 "That which can be securitized, will be securitized," Minsky wrote. 296 Lenders offered nonconforming mortgages and rolled back qualification standards.2 97 Soon, the system depended on a continuous supply of new home buyers.298 The new buyers' demand for houses kept prices high, and the rising property values justified the acquisition of large mortgages. 99 The large mortgages provided raw materials to securitize, and the strong performance of the housing market validated the high ratings that the CRAs awarded to the securitized products. 3" The high ratings also made trading in the products more profitable.30 ' Eventually, the chain broke, and the crisis started. 30 2 Two Bear Stearns hedge funds that had invested heavily in mortgage-backed securities failed.3 3 As lenders became aware of the potential for widespread defaults, 3 4 they 29I Minsky, supra note 249, at 281. 292 See, e.g., Kregel, supra note 18, at 6. 293 See, e.g., Wray, supra note z86, at 7. 294 Minsky, supra note 231, at 24. 295 See, e.g., Arestis & Karakitsos, supra note 28o, at 7-8. 296 Hyman Minsky, Securitization 2 (The Levy Econ. Inst. of Bard College, Policy Note No. 2oo8/2) (quoting participants of a conference of the Chicago Federal Reserve Bank in May, 1987); See also, Hyman Minsky, Securitization Outline, (The Levy Econ. Inst. of Bard College, Hyman P. Minsky Archive Paper 188, 1987) available at http://digitalcommons.bard.edu/hm-archive/188. 297 See, e.g., Kregel, supra note 247, at 17-18. 298 See, e.g., Kregel, supra note 247, at 18. 299 See, e.g., The Fed Discovers Hyman Minsky, supra note 225. 300 See, e.g., Amadou, supra note 7, at 3. 301 See, e.g., Kregel, supra note 247, at 18. 302 See infra text accompanying notes 304-307. 303 Barbara Kiviat, Bear Stearns Is Gone; Now Comes The Trial, TIME, Sept. 15, 2009, available at http://www.time.com/time/specials/packages/article/o,288o4,19232o3- 19232011923189,oo.html #ixzz23c7P5pDy. 32 Columbia Journal ofAsian Law, Vol. 27, No. 1 (2013) stopped extending short-term credit, and housing prices began to fall.3 5 In the first quarter of 2oo8, the American economy contracted more than six percent, and eight million jobs disappeared. 3 6 C. Minsky's Vision of the Crisis: "Financial Regulation is Both Indispensable and Imperfect" 30 7 What solution would Minsky have proposed? He advocated for public institutions to impose limits on credit and financial innovation in order to break financial cycles.) °8 "The problem of finance that will emerge," he wrote, "is whether the . . . institutions of national government can contain . . . financial fragility."3"9 Three basic characteristics and two more specific warnings emerge from his writings.3 ° This part proposes the elements of a resolution that he might have supported. First, Minsky called for robust public regulation, not reliance on private "gatekeepers."3 ' "Apt intervention and institutional structures are necessary for market economies to be successful," he wrote.3"2 Regulators had to "constrain the impact of uncertainty. '" 31 3 Second, Minsky believed that the regulators needed to strive continuously to restrict financial innovation. 314 Regulators, he wrote, should guide "the evolution of financial practices . . . to reduce the likelihood that fragile 3O4 See, e.g., Mark Pittman, Bear Stearns Fund Collapse Sends Shock Through CDOs (Update2), BLOOMBERG, June 21, 2007, available at http://www.bloomberg.com/ apps/news?pid=newsarchive&sid=ahWflEJ7dra4. 305 See, e.g., Dallas, supra note 23, at 295. 306 Gadbaw, supra note 14, at 556. 307 James K. Galbraith, Keynote Lecture to the 5th Annual Dijon Conference on Post- Keynesian Economics at the Roskilde University, Denmark (May 13, 2on) audio available at http://utip.gov.utexas.edu/ (describing Minsky's beliefs). 3o8 See, e.g., Hyman Minsky, Longer Waves in Financial Relations: Financial Factors in the More Severe Depressions 11, 29 J. ECON. ISSUES 83, 93 (1995). 3°9 !d. 310 See Part III.C. 31 See infra text accompanying notes 313-314. 312 Ferri & Minsky, supra note 228, at 24. 133 Hyman Minsky, Uncertainty and the Institutional Structure of Capitalist Economies: Remarks upon Receiving the Veblen-Commons Award, 30 J. ECON. ISSUES 357, 359 (1996). 314 See infra text accompanying notes 316-317. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 33 situations conducive to financial instability will develop." 3' As new instruments entered the markets, they had to keep their rules up to date.3'6 Third, Minsky wanted the regulators to impose countercyclical measures, in order to limit speculation and maintain stability. 3 1 7 "Institutions can act as the equivalent of circuit breakers," he wrote. 318 They could halt the inevitability of "euphoric" expansion . 31 9 More specifically, Minsky called for banks to act solely as lenders, rather than participate in "capital development."320 "If the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions," he wrote, then "they are in a better position to attenuate the disruptive expansionary tendencies of our economy. " 32' He proposed that regulators should require "narrow banking,"322 and promote an economy of small banks financing small, local deals.323 Finally, Minsky also advocated the restriction of financial trading to tangible assets.3" He emphasized the dangers of securitization in 1992, before the practice became prevalent. "The instrument originators and the security underwriters did not hazard any of their wealth on the longer term viability of the underlying projects," he wrote.325 "All that was required for the originators to earn their stipend was skill avoiding obvious fraud .... 326 31' Minsky, supra note 249, at 322. 316 See, e.g., Randall Wray, Minsky Crisis 2 (The Levy Econ. Inst., Working Paper Series No. 659, 2011). 317 See, e.g., Gabilondo, supra note 222, at 489. 3t8 Hyman Minsky, Domenico Delli Gatti, and Mauro Gallegati, Financial Institutions, Economic Policy, and the Dynamic Behavior of the Economy 2 (The Levy Econ. Inst. of Bard College, Working Paper No. 126, 1994). 319 See, e.g., Cassidy, supra note 247 (the "way to break this pattern was for the government to step in and regulate the moneymen."). 320 Hyman Minsky, Financial Instability and the Decline (?) of Banking: Public Policy Implications 13 (The Levy Econ. Inst. of Bard College, Hyman Minsky Archive, Paper 88, 1994), available at http://digitalcommons.bard.edu/cgi/viewcontent.cgi?article=lo87& context=hmarchive. 321 Minsky, supra note 249, at 281. 322 Minsky, supra note 32o, at 13. 323 Hyman P. Minsky, Dimitri B. Papadimitriou, Ronnie J. Phillips, & L. Randall Wray, Community Development BankingA Proposal to Establish a Nationwide System of Community Development Banking 9 (The Levy Econ. Inst. of Bard College, Working Paper No. 3, 1993). 314 See infra text accompanying notes 326-327. 325 Hyman Minsky, The Capital Development Of The Economy And The Structure Of Financial Institutions 22 (The Levy Econ. Inst. of Bard College, Working Paper No. 72, 1992). 326 Id. 34 Columbia Journal of Asian Law, VOL. 27, No. i (2013) The measures Minsky suggested appear more difficult to implement than moderating conflicts of interest among the CRAs.3"7 Public regulation that limits tendencies towards economic expansion and the dynamics that introduce instability would demand the resolution of other complex questions. 32 Regulators would have to address, for example: i) how to compensate the financial sector to attract talent but discourage excessive risk taking; 2) how to direct credit to prudent borrowers while preventing irresponsible lending; and 3) how to cultivate community values that would reject the natural inclination to maximize profit.32 9 Minsky, however, stressed the stakes: In the absence of policy that "assures that the economic prerequisites for sustaining the civil and civilized standards of an open liberal society exist,"330 he wrote, market behavior that creates "uncertainty and extremes in income maldistribution and social inequalities [will] attenuate the economic underpinnings of democracy."33' IV. SPOTLIGHT INDIA: CONFLICTED RATING AGENCIES AND DELIBERATE DEREGULATION India provides additional insights into ways to resolve the conflict in the West. 332 The country developed local CRAs that used the "issuer-pays" model.333 The Indian economy, meanwhile, transformed in patterns similar to those that Minsky predicted. 3' The government deregulated and expanded the debt markets and fostered growth in securitization. 335 Will the agencies succeed in stabilizing the Indian economy, because differences in their supervision mitigated their conflicts of interest? Or, have speculation and financial innovation been the critical concern, and will economic fragility increase without countercyclical interventions? This section first introduces the Indian CRAs and compares them to their Western counterparts. Second, it 327 See, e.g., Gabilondo, supra note 222, at 470 ("the idea that the government should actively intervene in the financial market faces renewed political opposition"). 328 See, e.g., Cassidy, supra note 247. 329 Id. 330 Minsky, supra note 313, at 15. 331 Id. 332 See rest of Part IV below. 333 Ministry of Finance, Capital Markets Division, Report of the Committee on Comprehensive Regulation for Credit Rating Agencies, Dec. 2009 [hereinafter Report of the Ministry of Finance] at 13, available at http://rbidocs.rbi.org.in/ rdocs/PublicationReport/Pdfs/CCRAo3o31oR2.pdf 334 See infra Part IV.B. 331 See, e.g. Shroff, supra note 38, at 96; Timothy Massad, Doing Business in India 2009: Critical Legal Issues for U.S. Companies, 1720 PLI/Corp 33, 42 (2009). The Indian Anomaly: Rethinking Credit Rating Agency Regulation 35 investigates parallels between recent changes in the Indian economy and Minsky's financial instability hypothesis. A. More Conflicts of Interest: Credit Rating Agencies in India CRAs in India resemble agencies in the West but have significant differences. 6 They have profited from charging issuers for ratings, 337 an arrangement that would suggest conflicted interests. 3 3s Since 1999, however, public regulators have overseen them.339 New activities have also diversified their revenue sources." ° 1. Soaring Market Values Six CRAs operate in India." CRISIL opened first, in 1987, and now leads the market." 2 In 1991, a consortium of Indian financial institutions launched a second agency, ICRA. 3 Three Indian banks own another agency, CARE. 3 In 336 See rest of Part IV below. 7 See Report of the Ministry of Finance, supra note 333 at 13. 338 See, e.g., Turmoil in U.S. Credit Markets: The Role of the Credit Rating Agencies: Hearing Before S. Comm. on Banking, Housing, and Urban Affairs, lloth Cong., 2nd Sess. 32 (2oo8) (testimony of Arturo Cifuentes) [hereinafter The Role of Credit Rating Agencies Hearings - Cifuentes] available at http://www.banking.senate.gov/public/ index.cfm?FuseAction=Hearings.Testimony&HearingjlD=7o 9 b68d2-6e2b- 4o4 8-bf86- l9fdcolecec3&Witness ID=62f465o6-891d-45a7-9c3c-68683ecb 5163 ("One could make the case that that whenever a rating analyst is supervised by a manager whose compensation is determined by market share or revenue growth (rather than ratings accuracy) the objectivity of ratings is compromised."). For a discussion of a study finding a positive correlation between the "issuer-pays" model and high ratings and more downgrades, see Dallas, supra note 23, at 265, 341. 339 See infra Part IV.A.2. 340 See infra Part IV.A.3. ' See text accompanying notes 342-345. Also, the fifth agency rates only small issuers and the sixth is the subsidiary of a foreign company. 342 See Report of the Ministry of Finance, supra note 333. Standard & Poor purchased a controlling stake in 2005, see id. "' ICRA, Profile, available at http://www.icra.in/67654323.aspx?ck=pXKT5F8DIoyo9YcC TjHIsZoyuA4irniXMUvRbEmAkRBQKECpIVZmNCoJ 3VCiLt2Xfnxc5w2uaDrqRYouEKC oCw==. In 2001, Moody's purchased a 29% stake in ICRA, see Moody's in India, available at http://www.moodys.co.in/. 3" Stephen Wells & Lotte Schou-Zibell, India's Bond Market - Developments and Challenges Ahead, Asian Development Bank Working Paper Series on Regional Economic Integration No. 22, Dec. 2oo8 at 24, available at http://aric.adb.org/pdf/workingpaper/WP22 lndia%27sBondMarket.pdf. Columbia Journal of Asian Law, Vol. 27, No. 1 (2o13) 2007, former bankers and regulators in Bangalore incorporated the newest agency, Brickwork."45 The CRAs acquired a "gatekeeping" role in the financial markets.46 Indian law mandated that at least one agency must evaluate every financial product.1 7 The rule increased ratings volumes, and CRISIL, for example, has graded more than 30,000 issuers. 348 In most other countries, including the United States, the United Kingdom, and Australia, ratings have been voluntary. 349 All six CRAs have performed successfully. 350 CRISIL's net profits increased by twenty percent between January and March 2012, 31 and it attained a market value of $1.3 billion in May.352 ICRA acquired subsidiary companies, and operates in Kuwait, the Philippines, and Indonesia, among other countries.3 53 In 2011, a shareholder deal valued CARE at $400 million dollars, and the agency has plans for a public offering.154 2. Conflicts of Interest The CRAs adopted the same "issuer-pays" model that Western governments blamed for producing conflicts; 355 however, Indian regulators started supervising the agencies early and aggressively.356 The Securities and Exchange Board of India ("SEBI") 357 has overseen the agencies' evaluations of 3 See History, http://www.brickworkratings.com/history.html. 3,6 See, e.g., M. T. Raju, Upasana Bhutini, Anubhuti Sahay, Corporate Debt market in India: Key Issues and Policy Recommendations, SEBI Working Paper Series No. 9, July 2004 at 17 (The agencies are "well ... regarded," and their ratings "carry confidence in the market."). 34 7 See Jain & Sharma, supra note 6, at io6. 348 CRISIL, Credit Rating List, available at http://crisil.com/ratings/credit-ratings- list.jsp. " Jain & Sharma, supra note 6, at io6. 350 See, e.g., India's Ratings Agencies Are Thriving, THE ECONOMIST, Mar. 17, 2012. 311 Crisil Net Up 20% in First Quarter; THE HINDU BUSINESS LINE, Apr. 16, 2012. 32 See, e.g., Moneycontrol, India Financial Portal, available at http://www.moneycontrol.com/india/stockpricequote/miscellaneous/crisil/CRI. 133 See ICRA Over the Years: A Chronicle, available at http://www.icra.in/67654323.aspx ?ck=fQoV 5tzY6LgysX63y6bYl/G41LXpEZoJvrL4hRRftR6erTJmmiLvW 74 oWKBgqhO2V orEIRIEJ8kCWPcbftqMdg==. 31 See India's Ratings Agencies Are Thriving, supra note 350. 311 See Report of the Ministry of Finance, supra note 333, at 13. 356 See rest of Part IV.A.2. 357 Raju, Bhutdni & Sahay, supra note 346, at 7. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 37 most financial products since 1999.358 In the United States, by comparison, the SEC began actively monitoring the CRAs in 2007."' The EU recently drafted its first mandatory provisions. 36 SEBI has exercised greater power than Western regulators. Since 1999, it has required the Indian CRAs to seek its authorization to conduct business.36' The agencies must renew the licenses every three years.362 The SEC, by contrast, grants permanent recognition.363 SEBI can also subpoena the agencies' records and employees and conduct examinations under oath.364 Additional institutions complement SEBI's oversight. 36 ' The central bank, the Reserve Bank of India ("RBI"), supervises ratings of securitized products 3 6 and must consent before agencies can grade bank loans. 36 , Other public entities, such as the Ministry of Petroleum and the Directorate General of Shipping, also regulate the agencies' activities.368 In 1999, SEBI set out mandatory rules that specifically addressed conflicts of interest,369 and it updated them in response to the global financial crisis.3 ° "Clause u" instituted an enforceable code of conduct that restricted the CRAs from the "unfair practice of diverting the clients of other agencies on assurance of higher ratings.' 37' It also required the agencies to "maintain an arm's length relationship between ... credit rating ... and any other activity" and to "refrain from creating a false market." 372 In the wake of the global crisis, 318 Anuradha Guru, Concerns on the Role of Credit Rating Agencies in the Evolving Financial Regime: A Policy Perspective, NSE NEWS, Sept. 2oo8, at 7, available at http://ssrn.com/abstract=14396 59; see Report of the Ministry of Finance, supra note 333, at 12, 24. 359 Himanshu Bhushan, Credit Rating Agencies in India: Have We Done Enough ii (Jan. 31, 2012), available at http://ssrn.com/abstract=1999886. 36o Report of the Ministry of Finance, supra note 333, at 24. 361 Bhushan, supra note 359, at 2, 12. 362 Jain & Sharma, supra note 6, at 104. 363 Report of the Ministry of Finance, supra note 333. 364 See Bhushan, supra note 359, at 15-16; Jain & Sharma, supra note 6, at 3; Guru, supra note 358, at 7. 365 Bhushan, supra note 359, at 1o. 366 id. 367 Report of the Ministry of Finance, supra note 333, at 27. 368 Id. at io. 369 Guru, supra note 358, at 7. 370 See infra text accompanying notes 371-374. 371 Report of the Ministry of Finance, supra note 333, at 24; Jain & Sharma, supra note 6, at 104-105. 372 Bhushan, supra note 359, at 23. Columbia Journal ofAsian Law, Vol. 27, No. 1 (2013) various governmental committees reviewed the "issuer-pays" model and concluded that it did not threaten the economy. 3 SEBI tightened some provisions on disclosure and imposed new prohibitions on analyst participation in marketing, business development, and share ownership in rated companies. 374 3. Diversification The Indian CRAs have broadened their sources of revenue, potentially blunting some of the conflicts of interest that the "issuer-pays" model might generate.3 75 Most agencies in India have rated a diverse range of financial products and institutions, and have also provided additional services. 37 6 Their enlarged pool of clients has made retaining individual customers less critical to their profits. CRISIL, for example, has earned half of its revenues from abroad by conducting a variety of ratings and undertaking several other tasks. 3" In addition to rating standard financial products, it has assessed bank loans and real estate, and has evaluated more than 14,000 small businesses. 3 78 It has developed risk-management models for banks and provided research and analysis to insurance companies. 379 It has also advised the Indian government on reforms to improve public institutions and infrastructure development. 38 o Other CRAs have pursued similar profiles. 38' The managing director of ICRA has estimated that less than sixty percent of its revenues derive from credit ratings.382 It started rating business and engineering schools, 38 3 and the newest agency, Brickwork, has graded hospitals and diagnostic labs. 38 4 3 Shroff, supra note 38, at 127. 7 Bhushan, supra note 359, at 18; Shroff, supra note 38, at 127. 315 See rest of Part IV.A. 3. 376 See, e.g., Report of the Ministry of Finance, supra note 333,,at 18. 3' Angel Broking, CRISIL, 2, 10 (Jan. 10, 2010), available at http://smartinvestor.business-standard.com/BSCMS/PDF/crisil1201ol.pdf. 378 Id. 379 Id. 380 Idt. 381 See infra text accompanying notes 383-385. 3 8 2 See India's Ratings Agencies Are Thriving, supra note 350. 383 See, e.g., Prashant K. Nanda, Now Crisil, cra to Rate Engineering, B-Schools, LIVEMiNT.COM and WALL ST. J., May 8, 2012, available at http://www.livemint. com/2012/05/o8223213/Now-Crisil-Icra-to-rate-engin.html. 384 See, e.g., Brickwork Careers, http://www.brickworkratings.com/careers.html. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 39 Regulators have directed the CRAs to offer additional services. 38 s State energy utilities have called on the agencies to rate their performance. 3 1 SEBI requires companies that list on public stock exchanges to hire the agencies to rate their shares, in order to help investors evaluate them. 387 B. Adherence to Minskyian Pardigms: Indian Market Development The Indian CRAs, though regulated and diversified,38 8 have operated in evolving financial markets that have appeared to reflect tendencies towards "euphoria," as Minsky forecast. 38 In 1991, India abandoned a statist economic system, characterized by government control of industry and slow growth, and began to implement a program of economic liberalization.390 It actively developed its debt markets. 391 It also deliberately fostered trading in securitized financial instruments,3 92 including the mortgage-backed securities at the center of the recent global financial crisis.3 93 This part observes India's economic development through the framework of Minsky's financial instability hypothesis. 1. Market Liberalization and Increased Cash Flow: Minsky Phase 1? The period after 1992, in which the state began to reduce its role in the Indian economy has borne some resemblance to the initial growth phase of Minsky's financial instability hypothesis.3 94 Upon independence in 1949 , India grew slowly.395 The country rejected the colonial experience for the Soviet 385 See infra text accompanying notes 387-388. 38 Deeptha Mathavan, From Dabhol to Ratnagiri: The Electricity Act of 2oo3 and Reform of India's Power Sector, 47 Colum. J. Transnat'l L. 387, 415-16 (2009). 387 Massad, supra note 335, at 44-45; Jain & Sharma, supra note 6, at io6. 38 See supra Part IV.A. 389 See rest of Part IV.B. 390 See, e.g., Afsharipour, supra note 26; Bala N. Balasubramanian, Bernard S. Black & Vikramaditya S. Khanna, Firm-Level Corporate Governance in Emerging Markets: A Case Study of India, U. Michigan Law & Economics, Olin Working Paper o8-on, July 2, 2008 at 5.. " See, e.g., Raju, Bhuttni & Sahay, supra note 346; Rajesh Chakrabarti, Bond Markets in India 2 (June 21, 2oo8), available at http://ssrn.com/abstract=n49322. 392 See infra Part IV.B.3 . "I See, e.g., Schwarcz, supra note 103, at ni65, 1178. 311 See rest of Part IV.B.. 391 See, e.g., Afsharipour, supra note 26, at 1029, 1o53; Franklin Allen, Rajesh Chakrabarti, and Sankar De, India's Financial System 2, Nomura Occasional Series on 40 Columbia journal of Asian Law, Vol. 27, No. 1 (2013) model of state intervention. 396 Until the early 198os, the economy expanded by an average of only 3.5%, a situation referred to as the "Hindu rate of growth."397 The new leaders suppressed private competition through strict licensing requirements. 398 High tariffs isolated the country from the rest of the world, and restrictions on exports suppressed corporate profits.39 9 Government nationalization of the banks limited access to investment capital.40 ° The RBI controlled interest rates and became the primary source of credit.40 ' Investors turned to government-sponsored financial institutions for finance rather than to the debt and equity markets.4"2 The state barred investors from trading bonds among themselves and taxed bonds purchased directly from issuers heavily.40 3 It -forbade private firms from issuing new shares.4 4 In 1992, declines in the value of the rupee made liberalization necessary, and a period of economic growth began.4 °5 Over the course of one summer, the country transitioned to a market-based system. 4°6 The finance minister abolished licensing requirements, opened the economy to foreign investment, Contemporary Capital Markets, Oct. 27, 2007, available at http://ssrn.com/ abstract=1261244. 396 Balasubramanian, Black, & Khanna, supra note 390, at 5. 197 John Armour & Priya Lele, Law, Finance, And Politics: The Case Of India, 43 Law & Soc'y Rev. 491, 496 (2009). '9Afsharipour, supra note 26, at 1053. 399 Id.; Viswanathan, supra note 34, at 46-47. 4' Amelia Ames, Foreign Institutional Investment In India: What A Portfolio Manager Needs To Know About The Past, Present, And Potential Future Of India, 4 B.Y.U. Int'l L. & Mgmt. Rev. 143, 152 (2008). 4"' Armour & Lele, supra note 397, at 491, 518. 402 Suchismita Bose and Dipankor Coondoo, A Study of the Indian Corporate Bond Market, 2 Money & Finance 25, 30 (2003); R.H. Patil, Broadbasing and Deepening the Bond Market in India 2 (Wharton Financial Institutions Center Working Paper Series 01-32), available at http://fic.wharton.upenn.edu/fic/papers/ol/o1 32.pdf. In response to nationalization of the banking system, many individuals turned to commercial chit funds, which exploited a legal loophole to compete with government banks, see Jan Eeckhout and Kaivan Munshi, Mitigating Regulatory Inefficiency: The Non-market Response to Financial Regulation in India, Selected Working Papers, University of Pennsylvania and Brown University, June 2005 at 947-48. 403 See, e.g., Patil, id. 404 Balasubramanian, Black & Khanna, supra note 39o, at 5. 40I Allen, Chakrabarti & De, supra note 395. 406 One More Push, THE ECONOMIST, July 23, 2011. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 41 and reduced state intervention in the private sector." 7 Banks privatized and tariffs and other trade barriers fell.4 s The capital markets became energized but succumbed to a series of scandals. 409 Companies sold shares and used the proceeds to expand . 4 0 Foreign institutional investors, overseas companies, and non-resident Indians invested.4 1 ' The markets grew lawless: First, the broker Ketan Parekh and other businessmen created a stock bubble that collapsed in 2001, causing the SENSEX index of the Bombay Stock Exchange to fall by 176 points. 42 In subsequent "vanishing companies" scandals, rogue companies took advantage of optimistic investors and lax enforcement by selling shares to the public, then disappearing. 4 'i Substantial irregularities emerged in the financial statements of the Tata Finance company, an affiliate of the Tata Group, one of India's largest and most prominent businesses.4"4 Regulators enforced rules leniently. 45 Some market observers promoted an Indian Sarbanes Oxley Act, akin to the American legislation that followed the Enron scandal, 4' 6 but the plan did not succeed.417 When SEBI adopted a new listing rule mandating independent directors on corporate boards, connected directors redesignated themselves as independent directors to appear to meet the requirements.' 8 SEBI never delisted a company for flouting the rule, and it dropped the few enforcement actions it tried to pursue.4 19 407 Balasubramanian, Black & Khanna, supra note 390, at 5. 408 id. 409 See infra text accompanying notes 410-414. 410 Mohanty, supra note 43, at 236; Balasubramanian, Black & Khanna, supra note 390, at 5. 41' Armour & Lele, supra note 397, at 503. 412See, generally, collection of articles published in the India Times, available at http://articles.economictimes.indiatimes.com/keyword/ketan-parekh/recent/3. 413 Mohanty, supra note 43, at 239 (2006). 414 Id. 411 See infra text accompanying notes 416-419. 416 Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, § 206, ni6 Stat. 745, 774 (15 U.S.C. § 78j-i (2006)). 417 Mohanty, supra note 43, at 232, 250; Balasubramanian, Black & Khanna, supra note 390, at 5. 418 Afra Afsharipour, Directors As Trustees Of The Nation? India's Corporate Governance And Corporate Social Responsibility Reform Efforts, 34 Seattle U.L. Rev. 995, 1005 (2011). 419 Afra Afsharipour, The Promise and Challenges of India's Corporate Governance Reforms, 1 INDIAN J.L. & ECON. 33, 64-67 (2010). 42 Columbia Journal of Asian Law, Vol. 27, No. 1 (2o13) 2. Deregulation and Debt Accumulation: Minsky Phase 2? The program of market liberalization ended credit rationing, 4 0 and more consumers and companies assumed higher levels of debt, as Minsky predicted. 42' Between 1994 and 2010, Indian bond markets grew by 2,000%.42 The increased access to credit enabled consumption and investment, 4" but it also amplified sensitivity to variations in interest rates.4 4 Market participants became more exposed to external shocks, the more debt that they acquired.4 25 The Indian government actively supported the revitalization of the bond markets. 426 SEBI pushed to remove regulations on pricing and limits on foreign buyers, despite recognizing the potential for instability:42 "In India,.... if money starts coming in all mutual funds will get in [sic] large quantities and if it starts going out it will go in huge quantities thus creating storms in the markets," it noted in a working paper.42s The Ministry of Finance established a High Level Expert Committee on Corporate Bonds to plan how to enlarge the markets.429 Regulators took deliberate steps to expand participation. 430 The Ministry of Finance, for example, allowed the introduction of exchange-traded corporate bonds.43' Exchange-trading enabled investors to purchase the bonds 420 See supra Part IV.B.i. 421 See infra text accompanying notes 422-425. 422 Anupam Rastogi and Vivek Rao, Product Innovations for Financing Infrastructure: A Study of India's Debt Markets 8, South Asia Working Paper Series No. 6, Oct. 2011, available at http://www.iadb.org/intal/intalcdi/PE/zo12/o964 5.pdf. CRISIL predicts that credit demand will grow at a faster rate than GDP. See Chakrabarti, supra note 391, at 2. 423 See, e.g., Rakesh Mohan, Recent Trends in the Indian Debt Market and Current Initiatives, available at http://www.dnb.co.in/FESConfrool/Uploads/Downloads/77/ Debt%2oMarkets%2oRM.pdf; Raju, Bhut~ni, and Sahay, supra note 346, at ii. 41 See, e.g., Guy Debelle, Household Debt and the Macroeconomy, BIS Quarterly Review, March 24, 2004 at 51. 425 Id. at 57, 62; see also Raju, Bhutini, & Sahay, supra note 346, at 21. 426 See infra text accompanying notes 427-429. 427 SEBI, Developments in the Corporate Bonds and Securitization Market, An Update, Feb. 24, 2o12 at i, available at http://www.sebi.gov.in/cms/sebidata/attachdocs/ 1330 4 9215 25 5 8.pdf. 428 See, e.g., Raju, Bhutini, & Sahay, supra note 346, at 22-23. 429 Rahul Saraogi, Rule of Law Determines Depth of Debt Market (India Knowledge Wharton Series, Aug. 18, 2011), available at http://knowledge.wharton.upenn.edu/ india/article.cfm?articleid=4642; Improving Indian Securitization Markets, supra note 467, at i. 430 See infra text accompanying notes 431-434. 4 See, e.g., SEBI, Developments in the Corporate Bonds and Securitization Market, An Update, Feb. 24, 2012 at 6, available at http://www.sebi.gov.in/cms/sebi-data/ attachdocs/133o492152558.pdf. New rules also enabled institutional investors and long- The Indian Anomaly: Rethinking Credit Rating Agency Regulation 43 from other investors on a formal platform, rather than buying them only from the original issuers. 432 To attract individual consumers, the Ministry also reduced the minimum size of trades 433 and lowered income taxes on interest payments. 434 The central bank introduced increasingly speculative products. 435 In 2010, it reported: "There were some legal, regulatory and institutional bottlenecks impeding the development of the corporate bond market in India, many of which have been addressed in recent years."136 Zero-coupon corporate bonds, for example, allowed investors to buy bonds at a discount, then receive the full value plus interest on maturity.437 Prices of zero-coupon bonds tend towards more volatility than those that pay out interest continuously. 43s SEBI relaxed numerous regulations that controlled risk.439 In 2007, it eased issuers' mandatory disclosures to potential investors and requirements to obtain ratings.44 ° It also reversed rules that restricted public bonds issues to investment-grade debt, and higher-risk bonds proliferated. 4" The proportion of single A-graded debt rose from 9.4% in 2005 to 20.7% in 20o9. 42 Triple-B term investors such as pension and provident funds to increase their participation in the bond markets, see Reserve Bank of India, Financial Stability Report, March 25, 2010 at 4.32, available at http://rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage= &ID=586. 432 See, e.g., Plan for a Unified Exchange Traded Corporate Bond Market: A Report of the Internal Committee of SEBI, available at http://www.sebi.gov.in/commreport/ corporate-bondmarket.html. 43 See Financial Stability Report, supra note 431. 434 Patil, supra note 4o2; Securitisation in India: The Story So Far and the Way Forward, available at http://www.dnb.co.in/Arcil2oo8/Securitisation%2oin%zoIndia.asp; Wells & Schou-Zibell, supra note 344, at 24. 43 1 See infra text accompanying notes 436-438. 436 See Financial Stability Report, supra note 431 at 4.31. 43' Lakshmi Iyer, Dip Into the Debt Market, ENTREPRENEUR, June zolo, available at http://entrepreneurindia.in/dip-into-the-debt-market/4o88. 438 Mark Gergen and Paula Schmitz, The Influence Of Tax Law On Securities Innovation In The United States: 1981-1997, 52 Tax L. Rev. 119, 131 (1997). 439 See infra text accompanying notes 442-445. 440 SEBI, Developments in the Corporate Bonds and Securitization Market, An Update, Feb. 24, 2012 at 9, available at http://www.sebi.gov.in/cms/sebi-data/attachdocs/ 1330492152558.pdf ("SEBI put in place the simplified listing agreement for debt securities . .. issuers with listed equity who are already subject to detailed disclosure requirements, now have to make minimal disclosures."); Chakrabarti, supra note 391, at lO ("the mandatory number of credit ratings for a bond issue has been reduced from two to one"). "'Wells & Schou-Zibell, supra note 344, at 24, 28. 442 Id. at 29. 44 Columbia Journal of Asian Law, Vol. 27, No. i (2013) ratings rose from 4.4% to 23.1% over the same time frame, and non-investment grade bonds rose from o.8% to 9%. '1 More liberal regulation unleashed financial innovation. 4 " In 2oo8, the Ministry of Finance introduced a new type of bond to broaden international investment.445 The Foreign Currency Exchangeable Bond could be issued in foreign currencies and pay interest in them, as well. The Ministry also agreed with SEBI to allow repurchase agreements, or "repos," among individual investors. 446 In a "repo" transaction, one investor sells a bond to another, on the condition that the seller will repurchase the bond at an agreed price on a specific day.447 Although "repos" do not always increase risk, if one party in a sequence of "repo" transactions becomes unable to buy back the bond, the failure spreads through the chain of investors. 448 This occurred in the United States in 2005, for example, in the wake of the collapse of the financial services company Refco. 449 Investors have also accused bankers of using "repos" to hide the worsening financial condition of Lehman Brothers investment bank.4 0 3. Speculative Euphoria and Fragility: Minsky Phase 3? The deliberate process of expanding the Indian debt markets shifted from encouraging trade in traditional corporate bonds "' to encouraging securitization.4"' Securitization increases the availability of credit,4 53 but it also 443 Id. 4" See infra text accompanying notes 447-452. 44' See, e.g., Singh & Associates, Foreign Currency Exchangeable Bonds, Apr. 2008, available at http://www.asialaw.com/Article/1988861/Channel/i6958/Foreign- Currency-Exchangeable-Bonds.html. 446 See Chakrabarti, supra note 391, at 12. 447 See, generally, Randall J. Pozdena, Risk in the Repo Market, FRBSF Weekly Letter Sept. 13, 1985. "48 See, e.g., Michael Mackenzie and Henny Sender, Fed Seeks to Curb Repo Market Risk, Financial Times, Dec. 28, 2011. 449 Aaron Pressman, What About the Rest of Refco?, Bloomberg BusinessWeek, October 17, 2005. 450 See, e.g., Michael J. de la Merced & Julia Werdigier, The Origins of Lehman's 'Repo 1o5,' N.Y. Times DealBook, Mar. 12, 2olo, available at http://dealbook.nytimes.com/ 2010/03/12/the-british-origins-of-lehmans-accountinggimmick/; further In re Lehman Bros. Sec. & ERISA Litig., 799 F. Supp. 2d 258, 264 (S.D.N.Y. 2011). 4 See supra Part IV.B.2. 452 See rest of Part IV.B. 3. "' For a discussion of securitization lowering interest rates, see Schwarcz, supra note 103, at u65, 171. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 45 introduces instability, as Minsky predicted.4 54 The practice of securitizing debt severs the direct relationship between investors and issuers, which increases risk in several ways.455 First, securitization causes investors to lower their lending standards and extend more credit. 4 , 6 Investors typically decide to lend to issuers based on their evaluations of the likelihood that the issuers will default, but securitization transfers the risk of default from investors to third parties.457 Because they will no longer bear the loss if issuers default, investors become less careful in their lending decisions. 45s Second, securitization causes underestimation of risk.4 59 The downstream investors who take on the risk of default have less information than the original investors . 4 " They may misjudge the likelihood of default, particularly as products grow more complex.4 6' Third, securitization makes market regulation more difficult.462 As the distance between issuers and downstream investors grows, markets become more interconnected and opaque. 46 3 In spite of these risks, the Indian government fostered trade in securitized products.4 64 In 2007, SEBI amended the definition of "securities" to include "securitized debt instruments," in order to allow securitized debt to be listed and traded on Indian stock exchanges.4 6 1 Trade volumes doubled within the "' See, e.g., Hyun Song Shin, Securitisation And Financial Stability, 119 The Economic Journal, 309, 312 (2009). 455 See, e.g., Kregel, supra note 18, at 5. 456 Schwarcz, supra note 103, at 1178. ("Because lenders to subprime borrowers did not have to live with the credit consequences of their loans, the argument goes, their loan underwriting standards fell."). 457 Id. 458 Willem H. Buiter, Lecture on Lessons From the Global Financial Crisis for Regulators and Supervisors (June 13, 2009), available at http://eprints.lse.ac.uk/29o48/ l/Lessons from-the-global financialcrisis.pdf ("What was not well recognized was that securitization, by breaking the link between, on the one hand, the originator of the loan and the party responsible for monitoring the loan over its life-time, and, on the other hand, the principal in the investing relationship - the owner of the securitized loan - weakens the incentives for collecting information and misplaces whatever information is collected."). 411 See, e.g., Geithner, supra note 470, at 9. 46o Id. 461 Id. 462 See, e.g., Nesvetailova, supra note 272, at 125, 133. 463 Id. 464 See infra text accompanying notes 465-468. 465 See, e.g, Varun Vaish, Regulations Surrounding the Listing of Securitized Debt Instruments, National Academy of Legal Studies and Research University of Law, Aug. 17, 2o at 3-4, available at http://ssrn.com/abstract=zo 7 123 8. Columbia Journal of Asian Law, Vol. 27, No. 1 (2013) year. 46 In 2009, representatives from SEBI, RBI, and the Ministry of Finance attended a securitization summit in Mumbai with private market participants, in order to discuss how to eliminate obstacles to growth of the securities markets. 46 7 In 2010, the Supreme Court endorsed trading in securitized debt by ruling that banks could legally transfer credit risk. 69 As Minsky wrote, "anything that can be securitized will be securitized, " 9 and the program to increase securitization included the packaging of residential mortgages, the same financial products involved in the global financial crisis.47 The volume of mortgage-backed securities in India increased sixty one percent between 2009 and 2010, and the value traded rose fifty three percent between 2011 and 2012.47' The National Housing Bank, the regulator of the Indian housing finance sector, pioneered their introduction in 2001 to expand property ownership through cheaper credit. 7' The Indian government instituted a "Five-Year Economic Plan" that estimated the money to be earned from mortgage securitization. a" As the growing market demanded new 466 See Chakrabarti, supra note 391, at 13. 467 National Institute of Securities Markets, Improving Indian Securitization Markets 2 (Nov. 2009), available at http://www.iperitus.com/docs/lndiaSecuritizationSummit 2oo9-WhitePaper.PDF. 468 Kalpesh Gada & Remika Agarwal, ICRA, Update on Indian Securitisation Market 7 (May 2012), available at http://www.icra.in/Files/Articles/Indian%zoSecuritisation.pdf. '69 Hyman Minsky, Securitization, The Levy Economics Institute of Bard College, Policy Note, 2oo8/2 at 2, quoting participants of a conference of the Chicago Federal Reserve Bank in May, 1987; further Hyman Minsky, Securitization Outline (1987), Hyman P. Minsky Archive. Paper 188, available at http://digitalcommons.bard.edu/hm- archive/188. 470 See, e.g., Timothy Geithner, Macroeconomic Effects of Risk Retention Requirements io (Jan. 2011), available at http://www.treasury.gov/initiatives/wsr/Documents/Section %2o9 4 6%2oRisk%zoRetention%2oStudy%2o%20%28FINAL%2 9 .pdf; Douglas W. Diamond and Raghuram Rajan, The Credit Crisis: Conjectures About Causes and Remedies 4 (National Bureau of Economic Research, Working Paper No. 14739, Feb. 2009). 471 Securitisation Markets in India - a Post-Crisis Perspective, Inaugural address by Ms Shyamala Gopinath, Deputy Governor of the Bank of India, at the India Securitisation Summit 2oo hosted by the National Institute of Securities Markets (NISM), Mumbai, Aug. iO 2OlO at 3; Gada & Agarwal, supra note 468, at 5. 472 See, e.g., K.C. Iyer & G.C. Tripathi, Prepayment Analysis of Residential Mortgage Backed Securities For Indian Securitization Market (Feb. 3, 2oo8), available at http://ssrn.com/abstract=lO90013; National Housing Bank, Credit Enhancement to Residential Mortgage Backed Securities (RMBS) of Primary Lending Institutions by way of NHB Guarantee, available at http://www.nhb.org.in/Financial/GuaranteeNHB- website.PHP; National Housing Bank, NHB supports 1st MBS of BOB Housing Finance Limited, Press Release, Apr. 23, 2003, available at http://www.nhb.org.in/ Press%2oRelease/April28.php. 473 Reserve Bank of India, Report, available at http://rbidocs.rbi.org.in/rdocs/ PublicationReport/Pdfs/1o793.pdf ("The five-year Plan documents have repeatedly The Indian Anomaly: Rethinking Credit Rating Agency Regulation 47 mortgages to securitize, non-conforming mortgages with low introductory rates emerged, as they had in the West.474 In time, India embraced collateralized debt obligations ("CDOs"), a more complicated variety of security.4 7 1 CDOs reference underlying securitized products, such as mortgage-backed securities. 476 When they do, the mortgage assets can change over time, unlike typical mortgage-backed securities which remain static.4 n Investors purchase specific tranches that entitle them to different rates of return and priority of payment, so long as the holders of the original mortgages avoid default. 478 Regulators encouraged investment in other new financial products, such as derivatives.479 In 1996, SEBI supported legalization of derivatives trading and self-regulation by derivatives exchanges. '8 A derivative involves a contract between two parties that specifies payments based on the changes in the value of a designated variable. 8 ' While investors can use derivatives to hedge against risk, they can also acquire risk by using them to speculate on future market movements.482 The complexity of derivatives trades may also make it more difficult for rejulators to anticipate how the financial system will react to economic shocks.4 3 Interest rate swaps, in which investors bet on emphasised the need for developing a secondary mortgage market (SMM) for bridging the resource constraint confronting the housing sector. The Ninth Five-Year Plan has strongly recommended securitisation as an important source of funds for the housing sector and has envisaged Rs. 2500 crore to come by way of securitisation."). See Financial Stability Report, supra note 431 at 5.25 ("Some concerns have emerged. in respect of "teaser" rates for home loans offered by banks. These 'teaser' home loans initially have a low fixed interest rate, which in later years increases to higher levels."). 171 Securitisation in India: The Story So Far and the Way Forward, available at http://www.dnb.co.in/Arcil2008/Securitisation%2oin%2ondia.asp. 476 SECURITIES AND EXCHANGE COMMISSION, supra note 134 at 7. 477 Id. at 9. 478 Id. at 7, 31. 479 See infra text accompanying notes 482-488. '8' Dayanand Arora & Francis Xavier Rathinam, OTC Derivatives Market in India: Recent Regulatory Initiatives. and Open Issues for Market Stability and Development, Indian Council for Research on International Economic Relations Working Paper No. 248, Apr. 2oo at 8, 20. 481 Erik F. Gerding, Credit Derivatives, Leverage, And Financial Regulation's Missing Macroeconomic Dimension, 8 Berkeley Bus. L.J. at 29-31 (2011). 482 Id. at 37-38. 483 See, e.g., Richard Beales & Gillian Tett, Greenspan Warns on Credit Derivatives, FINANCIAL TIMES, May 5, 2005 ("'Rapid growth in the credit derivatives market has created considerable uncertainty about how the global financial system might react to any new economic shocks,' Alan Greenspan, Chairman of the Federal Reserve warned on Thursday. 'The sheer complexity of derivatives instruments, in particular, coupled Columbia Journal of Asian Law, Vol. 27, No. 1 (2013) changes in variable interest rates, gained popularity in India. 48' By 2006, the country had become the third largest market for derivatives tied to the value of gold. 48s Since then, it has grown into the largest market for derivatives tied to the value of single stocks. 486 CONCLUSION The lessons that the future of India holds for the West should not be exaggerated. Indian and Western regulators and CRAs are embedded in different environments. 8 , What would be suitable for a less-developed economy may not be adaptable to diverse, developed economies. 4 88 Nevertheless, watching India offers new evidence for evaluating the role that public institutions should play in regulating financial markets. To avoid instability, must they intervene to restrict increases in consumer credit and trade in speculative instruments? Can they instead delegate to private "gatekeepers," so long as they first align the "gatekeepers' incentives? The stakes for the Indian CRAs will rise. As the credit markets energize, they will have to make faster, more complicated judgments. Pressures on their integrity will intensify. If their performance remains strong, and if the economy improves, it would provide some indication that the agencies can assume governance functions and keep evolving financial markets in check. That would imply that it is prudent for Western regulators to focus on "exogenous" regulatory changes to mitigate the CRAs' conflicts of interest. If the future does not go well - if the agencies are unwilling to downgrade a powerful Indian bank, or expose a fraud in a securitized tranche 89 - then perhaps it confirms that private entities should not be given responsibility for financial stability. Instead, it might suggest that deeper, more meaningful structural changes are necessary to counter increasing fragility, as Minsky believed. Substantial efforts have been expended to reform the regulation of the Western CRAs. A robust campaign tried, and failed, to eliminate the "issuer- with the consolidation in the financial industry, made it increasingly hard for regulators and bankers to assess levels of risk,' he said."). 484 Arora & Rathinam, supra note 48o, at 9. 481 Wells & Schou-Zibell, supra note 344, at 4. 486 Id. 487 For a discussion of rule embeddedness, see Danielsen, supra note 24, at 23, 37-38. 488 See, e.g., Id. 489 For a discussion of the politics involved in ratings, see, e.g., Coffee, supra note 91, at 55. The Indian Anomaly: Rethinking Credit Rating Agency Regulation 49 pays" model in the American Dodd-Frank Act. 490 If the efforts have not been focused correctly, it is important to redirect them towards a more effective response. 49' India provides a reference for how intensively financial markets should be regulated, and by whom. 490 On the Franken Amendment, see, e.g., Daniel Indiviglio, Franken Amendment Would Bring Real Rating Agency Reform, THE ATLANTIC, May 6, 2010. 4" For a discussion of the difficulties investors and shareholders have in securing reforms, see John C. Coffee, The Political Economy of Dodd-Frank: Why Financial Reform Tends to be Frustrated and Systemic Risk Perpetuated, COLUMBIA LAW AND ECONOMICS WORKING PAPER NO. 4 14, Jan. 2012 at 3-4 (2012).