A handful of the agency’s [Office of Thrift Supervision] officials were always on the scene at an
A.I.G. Financial Products branch office in Connecticut, but it is
unclear whether they raised any red flags. Their reports are not made
public and a spokeswoman would not provide details.
Here is the story, interesting throughout. One response to this anecdote is to think we simply needed more regulators on the scene and indeed on many other scenes as well. A different response is to conclude that institutions of many different kinds work less well than we used to think.
I guess we can say that about all institutions, including – apparently – the institution which educates our economists.
S & P, Moody’s & Co., and Fitch–a portfolio manager tells me I shouldn’t overlook the culpability of these rating agencies for misjudging and then cloaking the risk involved in the sub-prime mortgage market. By law, investment banks and other financial entities would have been prohibited from adding so many risky mortgage-backed securities to their books. Pension funds, banks, money market funds, and insurers can only buy debt rated “investment grade† by a Nationally Recognized Statistical Ratings Organization (NRSRO). The SEC doles out this “recognition† and S&P, Moody’s, and Fitch are the only rating agencies so recognized. Since these rating agencies assessed the sub-prime packages as top shelf debt, co-signed and notarized by the SEC, the banks took the bait and swallowed the hook.
You would think that independent rating agencies would have every incentive to provide reliable information. But that would assume there was an open market for rating agencies, one without any barriers to entry. Unsurprisingly this is not so. The SEC uses its regulatory power in this respect to maintain an artificial monopoly for S&P, Moody’s and Fitch. As they say in television, complications ensue.
The rating agencies get fees for the ratings. The better the ratings the more sales that happen and the more fees they generate in the future. It’s a serious moral hazard, but I’m not sure how one would ameliorate it.
Another response would be that those who regulate were believers in the philosophy that NOT regulating is the best regulation. TCs idea is that someone lost a football match, because the game sucked, not because they are bad players. The idea that someone else could do a better job of regulation elicits a rolling of eyes from cons/libertarians who believe in inequality of abilities.
About rating agencies, Joe Stiglitz has some words here:
http://www.bloomberg.com/apps/news?pid=20601109&sid=ah839IWTLP9s&refer=home
“I view the ratings agencies as one of the key culprits,” says Joseph Stiglitz, 65, the Nobel laureate economist at Columbia University in New York. “They were the party that performed that alchemy that converted the securities from F- rated to A-rated. The banks could not have done what they did without the complicity of the ratings agencies.”
I don’t pay attention to ratings, but isn’t AAA great and then a day later AA means they are going out of business? That system doesn’t seem like it could ever really mean more than the first 1% of due diligence.
“Employees as Regulators,” by Moshe Adler, The New York Times Op-Ed, January 27, 2003
re. Drunken Priest (9/25 4:25)
“…insurers can only buy debt rated “investment grade† by a Nationally Recognized Statistical Ratings Organization (NRSRO). The SEC doles out this “recognition† and S&P, Moody’s, and Fitch are the only rating agencies so recognized.”
Seven agencies have been recognized by the SEC –
http://www.sec.gov/news/press/2007/2007-199.htm
CONGRESS: THINK BEFORE YOU ACT!
You are being asked to pass a $700 billion “bailout† or “rescue† package and are told by your leadership that it is “necessary† to prevent a catastrophe in the financial markets and, by extension, on Main Street.
Please think carefully about the following facts before you vote: ·
* Public opinion is running anywhere from 100:1 to 300:1 against passing this bill, according to sources on Capitol Hill. You must return home after you pass this package to ANGRY constituents with an election less than a month away. Given the massive size of this package, the fact that it rewards the guilty on Wall Street and does nothing to address the cause that anger is fully justified.
* Non-financial private debt is $32.4 trillion dollars1 as of 2Q 2008. Household debt is $14.0 trillion. Households lost 400 billion dollars last quarter. You wish to add $700 billion more in losses (via government obligations that taxpayers must cover) this quarter; this package is insignificant against the total bad credit outstanding. Federal capacity to “bail the system out† is insufficient.
* It will not and cannot work because the issue is trust, not money. There is lots of money (and credit) but it is being hoarded throughout the system. Consumer savings have gone from nothing to the highest rate ever in American history – in the space of a few months. Money is flying into Treasuries because of lack of trust, not lack of money. You must fix the cause of the problem, not apply band-aids.
* Commercial paper is being cited as the “lockup† that threatens an imminent financial train wreck. The truth is that commercial paper rates for “AA† rated non-financial firms is placing at a rate half that of a year ago as the Fed Funds target has been dropped from 5.25 to 2%2. With risk having increased the rate of return offered is lower? This is where the stress is coming from; at last summer’s rates this paper would roll. You are being gamed by Paulson and Bernanke; look at the table in the reference and you will see that even for “threatened sectors† rates are not materially higher than last year.
* If you pass this bill and the market implodes you will be held directly responsible. There are records of thousands of signatures across seven petitions faxed to you (at my expense) dating back to October of 2007 on this topic. Many experts, including Nouriel Roubini, “Mish† Shedlock, Dr. Faber, The Weiss Institute and over 160 economists have warned Congress that this proposed plan will not work. Are you prepared to face a full-page ad in the Wall Street Journal and/or USA Today exposing these facts?
* There are alternatives that will work; they all involve restoring trust and using existing market mechanisms to resolve insolvent institutions.3 While I am not particularly partial to my view on how we resolve “failed† institutions, addressing the root of the problem – lack of trust – is paramount. Three elements are involved here, they are obvious, and they must be fixed or you will FAIL.
* We only get one more shot at this; we have spent over $1.6 trillion thus far (by some estimates; $500 billion by others) attempting the same thing over and over again and it has not worked.
DO NOT PASS THIS BILL AS IT DOES NOT ADDRESS THE CAUSE AND WITHOUT DOING SO YOUR EFFORTS ARE DESTINED TO FAIL. THE VOTERS ARE RIGHT AND WILL HOLD YOU TO ACCOUNT SHOULD YOU THROW $700 BILLION INTO A FINANCIAL HURRICANE.
1. http://www.federalreserve.gov/releases/z1/Current/z1r-1.pdf
2. http://www.federalreserve.gov/releases/cp/
3. http://market-ticker.denninger.net/archives/593-CONGRESS-STOP-AND-THINK!.html
re: Karl (9/27 11:28)
“There were only the big three for the relevant time period for the current turmoil.”
Dominion Bond Rating Service Limited became an NRSRO in Feb 2003:
http://www.sec.gov/rules/concept/s71203/dominion080503.htm#P32_3413
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