Krugman: Berating the Raters

[chill_wind]

Berating the Raters


By PAUL KRUGMAN
Published: April 25, 2010

Let’s hear it for the Senate’s Permanent Subcommittee on Investigations. Its work on the financial crisis is increasingly looking like the 21st-century version of the Pecora hearings, which helped usher in New Deal-era financial regulation. In the past few days scandalous Wall Street e-mail messages released by the subcommittee have made headlines.

That’s the good news. The bad news is that most of the headlines were about the wrong e-mails. When Goldman Sachs employees bragged about the money they had made by shorting the housing market, it was ugly, but that didn’t amount to wrongdoing.

No, the e-mail messages you should be focusing on are the ones from employees at the credit rating agencies, which bestowed AAA ratings on hundreds of billions of dollars’ worth of dubious assets, nearly all of which have since turned out to be toxic waste. And no, that’s not hyperbole: of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent — 93 percent! — have now been downgraded to junk status.

What those e-mails reveal is a deeply corrupt system. And it’s a system that financial reform, as currently proposed, wouldn’t fix.

(bold emphasis mine) the rest: http://www.nytimes.com/2010/04/26/opinion/26krugman.html?hp

Dean Baker agrees:

Krugman Nails the Issue on Credit Rating Agencies
Monday, 26 April 2010 03:02

A big part of the story of the housing bubble is that the bond rating agencies were willing to give issuers of mortgage-backed securities collaterized debt obligations investment grade ratings even when they were clearly junk. The explanation was that the rating agencies were being paid by the issuers, therefore they had an enormous incentive to bend their ratings. If they rated these issues honestly, they would lose their business.

The conflict of interest in this "issuer pays" system has been widely noted. Unfortunately it has prompted mostly strange genuflecting rather than serious thinking. The obvious way to fix the conflict is to take away the hiring decision from the issuer. The issuer would still pay the rating agency but a neutral party -- the SEC, the stock exchange on which the company is listed, the local baseball team -- would make the decision as to which agency gets hired.

Some of us have been pushing this one for a while (e.g. here and also Plunder and Blunder), but Congress has preferred much more complex regulations that would have no impact on the basic conflict of interest. However, Paul Krugman comes to the rescue in his column today. Maybe now someone in Congress will be able to think clearly on this issue.

http://www.cepr.net/index.php/blogs/beat-the-press/