Ya’ll,
Something that has bothered me about the role of sub-prime mortgages in the recent economic crisis is that bundled “derivatives” (is that the right term?) containing these were given AAA ratings by a private ratings firm.
Questions: was this ratings firm actually private, who ran it, and why did it make such stupid decisions? Or am I missing something here?
Best Regards,
Tele
Because it’s a cartelised industry. I think there’s articles on it on Mises.org, explaining the government’s role in the ratings’ agencies ineptitude.
A quick search on mises.org didn’t get me any related results, but I’d very much appreciate any further clues pertaining this matter as well.
From what I’ve heard somewhere else, it had something to do with the legal shutdown of an “expertise market” for new rating competitors, but I didn’t find anything meaningful with these search words either.
I think the problem is more that Wall Street’s a tight little club and nobody wanted to rock the boat, particularly while the profits were still rolling in. This is just human nature. Of course, these loans would never have been offered in a truly free market without 1) government mandates such as the CRA 2) artificially cheap credit 3) the GSO’s, Fannie and Freddie and their distorting effects on the after-market. Also, the SEC by its very existence crowds out what would otherwise be a healthy market for due diligence auditors. Remove the government externalities, and the CDO’s and their derivative instruments would be a small, high-risk market and when a bust occurred, the ratings agencies would be sued out of existence for their misrepresentations.
Another point: I don’t think bubbles are always entirely a matter of people being misled by false economic signals. I think a lot of people just figure they can get in and get out before the scheme collapses. Or they face pressure from clients to dive in.
Also, isn’t there a circle of Wall Street banks that are “preferred dealers” contractually tied in to the Fed/Treasury for government bond auctions? This probably contributes to the cartelized nature of the whole industry.
Of course, it’s completely ridiculous to blame “the free market” for anything that happens in the pinko world of banking.
Still, the market does tolerate dissenting advice; keep in mind that Peter Schiff was a common guest on financial shows in the heyday of the mortgage boom, and even though he got laughed at and ridiculed almost every time, the invitations didn’t stop. Something similar should’ve been possible in the rating market as well, so long as the state hasn’t created an oligopoly there as well.
I wouldn’t say that they made “stupid” decisions, I would say they were attempting to maximize their profits within the framework of the MBS market which became riddled with malinvestment from government intervention in the housing sector of our economy.
Freddie and Fannie enabled and even encouraged mortgage issuers to make high risk loans by artificially protecting them from default.
Here’s a good basic primer on the MBS market, it’s written for brokers from the perspective of how mortgage rates are established:
Without government intervention, these bundled derivatives would be a tool for investors to spread out the default risk and legitimately provide lower interest rates to consumers.
I can’t remember which it was that discussed them. The comments sections on some of the articles do mention them though, which could be where I saw discussions of their cartelised, government-aided existence. It’s more or less along the lines of what Mike Shedlock says in this article.
Yeah, this sounds about right on all accounts. Even if they were purely private institutions, as long as a central planner is steering the economy, what choice does a private agency have except to go along for the ride? No competition means no alternative. The “preferred dealers” thing I haven’t heard a lot about.
Here’s one thing I ran into: supposedly, there are regulations that require investors to use credit ratings provided only by so-called “Nationally Recognized Statistical Ratings Organizations” (NRSROs), at least according to the AEI in recent talks. Now, I’ve not been able to find evidence that investors are strictly required to use these credit-rating agencies, and in fact, the designation appears to be purely voluntary: if one wants to be an NRSRO, you can register with the feds. Check it out: http://www.sec.gov/divisions/marketreg/tmcompliance/nrsro-secg.htm. One becomes an NRSRO in order to be used as a “credible source” by the SEC in their regulatory evaluations.
Anybody else know anything about this?
Now, here’s what I think is interesting: http://en.wikipedia.org/wiki/Nationally_Recognized_Statistical_Rating_Organization. Take a look at that list, and tell me how many of these agencies were involved in the sub-prime mortgage “scandal.” All of them? Why is this not proof that the regulatory agencies are worthless? People can say that “well, it’d be a lot worse without,” but short of complete nationalization of the banking system, you couldn’t regulate these agencies much more.