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Regulatory accountability
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.
Posted by Tyler Cowen on September 27, 2008 at 02:54 PM in Television | Permalink
Comments
I guess we can say that about all institutions, including - apparently - the institution which educates our economists.
Posted by: Hal at Sep 27, 2008 3:08:49 PM
Dear Tyler,
Note the sentence in the 4th graf of the NYTimes artice:
A collapse of the insurer threatened to leave a hole of as much as $20 billion in Goldman’s side, several of these people said.
Could this explain Goldman ex-employee Paulson's decision to bail out AIG? Does anyone besides me find it strange that Tyler, sitting at the center of public choice economics, has said almost nothing about the incentives that could motivate Paulson? Are we to assume that this guy who explicitly said he didn't want to be accountable and tried to get that in the bailout bill is just public-spirited?
Best,
David
Posted by: David R. Henderson at Sep 27, 2008 3:40:19 PM
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.
Posted by: Drunken Priest at Sep 27, 2008 4:25:16 PM
I've been doing a lot of reading up on fisheries, aquaculture, and the like. Today I happened upon an article discussing the causes of the 1992 cod collapse. Fascinating from a (nonpartisan) POV of examining the motivations and context of the regulators and the resulting effects on the system (disastrous).
http://arcticcircle.uconn.edu/NatResources/cod/mckay.html
Imperfect knowledge leads to bad planning decisions, right? Hayek told us so. Only, in a commons, decisions *must* be made.
Posted by: Russell L. Carter at Sep 27, 2008 4:35:12 PM
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.
Posted by: Bob Smith at Sep 27, 2008 6:01:12 PM
Comprehensive Oversight is impossible to accomplish. Everyone should know that.
Hell, I think you could make a post asking commenters for an example of a failure of any kind of oversight and you'd have over 200 comments
Posted by: Robert Olson at Sep 27, 2008 7:32:07 PM
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.
Posted by: Jesus saves America spends at Sep 27, 2008 7:36:05 PM
Comprehensive Oversight is impossible to accomplish
Strawman foul. This is due to an asset bubble which was obvious to anyone without minds poisoned by ideology. Greenspanism was at fault. Instead of admitting it, your attempt to deflect blame on regulation is ingenious. Everything fails.
Everyone remembers failures, but not successes of regulation.
Posted by: Jesus saves America spends at Sep 27, 2008 7:58:54 PM
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.''
Posted by: John B. Chilton at Sep 27, 2008 8:03:28 PM
Big, smart financial companies failed, but I'm not sure that's reason to conclude that they "work less well than we used to think."
To the extent that people involved are bailed out by government, the risks they took were probabilistically correct.
Also, every business is willing to go bust for the chance to profit. In that sense, some portion of the risk taken by fallen businesses shouldn't be considered "too much".
Posted by: Ian at Sep 27, 2008 8:08:41 PM
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.
Posted by: Andrew at Sep 27, 2008 8:36:42 PM
"Everyone remembers failures, but not successes of regulation."
Successes? Maybe you are right. Except for the huge majority of people who think that none of the problems wouldn't be fixed with more regulation. They have no clue what type, or how to make it good, just more.
And as for bad players, did I miss us going back to the spoils system? Did Bush get to replace all the footmen of the bureaucracy?
Posted by: Andrew at Sep 27, 2008 8:41:55 PM
At its first formal meeting, the new federal board overseeing the accounting profession proved George Stigler right. Mr. Stigler, who died in 1991, won a Nobel in economics for showing why regulated industries end up co-opting their regulators.
"Employees as Regulators," by Moshe Adler, The New York Times Op-Ed, January 27, 2003
Posted by: at Sep 27, 2008 9:05:53 PM
Here in the USA we have found that while the US government tends to do small simple things badly, it does big complex things even worse.
This is pretty much the biggest thing the US government has ever done. And we're going into it without any clarity at all about what can be done, what needs to be done, or what will be done after the project is approved.
Let's wait 4 months and get a better idea what needs to be done, and then let the new president make a proposal.
I think I'd have much more trust in a new administration that doesn't have a track record yet.
Posted by: J Thomas at Sep 27, 2008 9:15:49 PM
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
Posted by: William Dunn at Sep 27, 2008 11:01:22 PM
S&P, Moody's and Fitch were the only ones recognized before 2007, mostly thanks to Sen. Shelby pushing the Credit Rating Agency Reform Act of 2006 (mentioned at the link). There were only the big three for the relevant time period for the current turmoil.
Posted by: Karl at Sep 27, 2008 11:28:11 PM
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
Posted by: David S at Sep 28, 2008 1:26:02 AM
The very odd thing is that AIG are fundamentally an insurance company; they were writing very large sums of cover on a new kind of risk, and they apparently did not even try to lay off any substantial portion of the risk. Thrift regulators might not see that, but for insurance regulators it would have stood out as crazy behaviour. It should have looked crazy to AIG's own insurance accountants, underwriters and auditors. How come it did not?
Posted by: Diversity at Sep 28, 2008 4:14:48 PM
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
Posted by: William Dunn at Sep 29, 2008 2:50:36 PM
