The End of Gatekeeping: Underwriters and the Quality of Sovereign Bond Markets, 1815–2007

Abstract

We provide a comparison of salient organizational features of primary markets for foreign government debt over the very long run. We focus on output, quality control, information provision, competition, pricing, charging, and signaling. We find that the market setup experienced a radical transformation in the recent period, and we interpret this as resulting from the rise of liability insurance provided by rating agencies. Underwriters have given up their former role as gatekeepers of liquidity and certification agencies to become aggressive competitors in a new Speculative Grade market. JEL Classifications: F34, G14, G24, N2Keywords: certification, primary bond market, sovereign debt crises, banks competition CEB Working Paper N° 10/017 Keywords: certification, primary bond market, sovereign debt crises, banks competition JEL Classification: F34, G14, G24, N2♣ . This is the revised draft of a paper presented at the NBER International Seminar on Macroeconomics, Cyprus, June 12-13, 2009. The authors are indebted to interviewees from origination departments of investment banks and institutional investors for field research conducted in New York (Winter-Spring 2007). Marc Flandreau is grateful to Carlos Medeiros (then head of IMF's Capital Markets division) for exchanges that proved very helpful at an early stage of this research and to the IMF for hospitality when several of the ideas in this paper took shape. We thank Sara Bertin (then at Moody's), Michael Dicks (then at Lehman Bros) and Javier Santiso (OECD) for sharing with us their lists of contacts and insights. Excellent research assistance from Thomas Dickinson in interviews in NY is also acknowledged. Authors are also grateful to bank archivists in London and Paris for providing them with generous access to an incalculable number of boxes and material and to the Librarian at the Graduate Institute Yves Corpataux for help and support. Thanks to Vincent Bignon for a careful, speedy, and expert feedback on the pre-first draft. Thanks to Lucrezia Reichlin and Ken West for the invitation. Thanks finally to Vincent Reinhart and Albrecht Ritschl for comments, suggestions and challenges. The views expressed here are those of the authors and should not be attributed to the Organization for Economic Co-operation and Development (OECD) or the National Bureau of Economic Research (NBER). ♠ . Marc Flandreau is Professor of International Economics, Professor of International History and Politics andAssociate Professor of Development Studies at the Graduate Institute of international and Development Studies in Geneva, and a research fellow at CEPR. Juan H. Flores is Assistant Professor in economic history, University of Geneva. Norbert Gaillard is Post Doctoral Fellow at Sciences Po, Paris. Sebastián Nieto-Parra is economist at the Development Centre, OECD, Paris. "Wow. I hadn't thought of it through a historical perspective."John Grisham, The Partner (1997, p. 452) In the past twenty years, dedicated research efforts have helped us expand our knowledge of how the int...

What Financiers Usually Do, and What We Can Learn from History

“…The growing role of rating agencies in this field then diluted the responsibility of banks vis-à-vis their clients over the safety of the securities issued. As a consequence -and this differs from what had been the case previously -defaulting issuers are nowadays randomly distributed among underwriters, and the competition among underwriters became more aggressive and was based on prices rather than quality (Flandreau et al, 2009b). Moreover, strong competition among retail brokers -as in the 1920s in US -pushed the less established among them to sell to investors who were unable to bear the financial products they bought.…”

“…Till now, reputation has been an important incitation for leading underwriters to issue safe securities, the bulk of defaulting issuers concentrating in second-tier underwriters' hands (Flandreau et al, 2009b). Often, these second-tier underwriters entered the market just to get profit from bull times and took the lower end of the clientele.…”

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