Wednesday, October 24, 2007

Financial market turmoil: The problem is obvious, the fix is hard

The current explanation of why the trillion dollar securities market is in turmoil, which may push us into recession, is that mortgage-backed security pricing was inaccurate because credit-rating agencies didn't do their job.

Gee, I wonder why they didn't do their job? It's a mystery. Needs lots of investigation.

Or not ....

Robert Reich's Blog: Why Credit-rating Agencies Blew It: Mystery Solved

Recently, Treasury Secretary Hank Paulson sharply criticized credit-rating agencies for failing to recognize the risks in hundreds of billions worth of mortgage-backed securities whose values continue to plummet as home-loan defaults grow.

... obvious why credit-rating agencies didn't blow the whistle. (They didn't blow the whistle on Enron on Worldcom before those entities collapsed, either.) You see, credit-rating agencies are paid by the same institutions that package and sell the securities the agencies are rating...

As I've noted in other contexts, it's not necessary for anyone at the credit-rating agencies to actually conspire to create false results. It's simply emergent behavior -- natural selection in action. Competent honest people will fail to make their incentives, so they'll either become incompetent, move to other businesses, or become dishonest. It probably only takes 1-2 years of this type of conflict of interest to create agencies that are a mixture of incompetent and dishonest.

So the interesting question is not why the credit-rating agencies are dishonest and incompetent. That's obvious.

The interesting question is why Congress never fixed this back in the Enron days. The division was proposed then, probably by Robert Reich but also by the usual suspects (Krugman, DeLong, etc).

Oh wait, we know the answer to that one too. Congress is incented by reelection and retirement jobs, which are paid for by the .. the credit-rating agencies and securities company ...

Hmm. So why does Congress get away with such incompetency and corruption ...

Oh wait, we know the answer to that one too.

The newspapers don't write about this and the talk shows and television news groups don't educate the public.

I'll leave the rest of the "Oh, waits" to the reader.

The problem is the American voter.

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