Understanding rating addiction: US courts and the origins of rating agencies' regulatory license (1900-1940)

This paper discusses the regulatory license view that reliance by regulators on the output of rating agencies in the 1930s caused the agencies to become a central part of the fabric of the US financial system. Exploring pre-1930 court records, we find evidence of a growing reliance on the agencies that pre-dates the regulatory moves of the 1930s. We argue that courts began using ratings as financial community produced norms of prudence, providing a novel interpretation of the emergence of rating in financial systems as a product of trustee law. We remark that this created a legal license problem, creating incentives and conflicts of interest not unlike those which modern observers usually associate with regulation in the subprime crisis.