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One of the solutions Krugman cites is for the SEC to hand out the rating jobs to the agencies rather than allowing the institutions pick their agencies.

I suppose you could imagine, in the long term, the SEC rating the rating agencies on the accuracy of their forecasts and removing certification from ones who failed to do a good.

by Colman (colman at eurotrib.com) on Mon Apr 26th, 2010 at 12:11:44 PM EST
[ Parent ]
It's a good solution for the present situation and one that I support, but preventing self-interest from becoming a part of risk and credibility analysis is, according to the compelling work of Stiglitz and Arrow, always going to be a whack-a-mole game. It's not possible to get to Krugman's "idiot proof" lending environment for more than a short time because power (compelling individuals to surrender their own interests to those of the group) and self-interest are fundamental variables in any lending process.

For example, how well has the SEC actually performed its less critical job responsibilities up to now?  So why would we expect it to do much better job with greater power and responsibility over rating agencies?

by santiago on Mon Apr 26th, 2010 at 12:25:37 PM EST
[ Parent ]
But it's all always whack-a-mole: the system has to constantly adapt to technological innovation. This is the current problem with a lot of our systems - we design institutions in 1710 or 1810 or 1910 or 2010 and we expect it to not need changing in pretty fundamental ways as the world changes.
by Colman (colman at eurotrib.com) on Mon Apr 26th, 2010 at 12:31:25 PM EST
[ Parent ]
technological innovation and unexpected or expected results of long-term iterations.

In this case, perhaps the tree of credit needs to be periodically watered with the blood of rating agencies.

by Colman (colman at eurotrib.com) on Mon Apr 26th, 2010 at 12:32:39 PM EST
[ Parent ]
Yes, adaptation is an inherent element, which is the main argument against Krugman's thesis of "idiot-proofing" the system instead of relying of skilled actors.  (I tend to support Krugman on this, however, but there is a valid counter-argument to his case.)
by santiago on Mon Apr 26th, 2010 at 01:01:50 PM EST
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Also, Krugman's solution doesn't resolve the issue that most large securitized credit offerings like the big MBS deals that got us into trouble, ALREADY get rated by more than one, if not all, of the agencies, so it isn't picking the agency where a lot of the corruption occurs.  It's that there are costs and professional risks involved for any analyst and his or her employers, past, present, and future, in making a prediction that deviates too much from the common wisdom or expectations of the day. Look at the outrage and accusations of political manipulation that occurred when the agencies downgraded Irish debt, for example.  People can get fired or are otherwise punished for rating something bad that turns out to be good (and lots of times probably should be, just like doctors who operate when something less dangerous could have been done), so they tend toward status quo.  
by santiago on Mon Apr 26th, 2010 at 12:37:55 PM EST
[ Parent ]
Anonymize the ratings.
by Colman (colman at eurotrib.com) on Mon Apr 26th, 2010 at 12:42:27 PM EST
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It's a good idea, but one that comes through sacrificing much ability to hold bad rating analysts accountable and making it harder to tell if there is rampant insider corruption among their SEC regulators. That might be an acceptable cost right now, where the pressures of conformity have proven so great, but a few years down the road, the crisis narrative of the day could instead return to the more familiar story of government officials in cahoots with raters and former/future employers in banks to manipulate securities values, and everyone will be wanting to hang the criminals who advocated reducing the transparency of ratings agencies. Prediction: if anonymity and more control of ratings by government were to occur, a new set of non-governmental privately-hired rating consultancies would just develop in their place and eventually hold more credibility among market participants than the low-paid "government" ones like Moodys and S&P.  
by santiago on Mon Apr 26th, 2010 at 12:56:17 PM EST
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Sure, but they wouldn't hold any mandates under Basel II or the like - and the government could link the requirements for pension funds and the like  to the official rating agencies.
by Colman (colman at eurotrib.com) on Mon Apr 26th, 2010 at 12:59:43 PM EST
[ Parent ]
But there's the rub.  Why would the market respond favorably to rules set up by the government?  After a few years, those rules will be said to be too "old school" and inappropriate for new developments in the industry, and too politically cumbersome to update as well, leading to a new private industry doing the same thing rating agencies do now -- qualitative, privately compensated advice to very wealthy investors.  And people will believe the ones paid by the billionaires with real skin in the game before the government bureaucrats, like they do now in every filed regulated by government ratings and analysis.
by santiago on Mon Apr 26th, 2010 at 01:07:01 PM EST
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Anonymize and wikify the ratings.

And make all financial transactions public with standard non-vague on-book accounting definitions, so that anyone with a mind to can check a rating for themselves.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Apr 26th, 2010 at 02:41:25 PM EST
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Good idea.
by santiago on Mon Apr 26th, 2010 at 04:19:45 PM EST
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Why would the market respond favorably to rules set up by the government?

That's not the point. The point is the market only exists within the rules set up by government.

The brainless should not be in banking -- Willem Buiter

by Migeru (migeru at eurotrib dot com) on Mon Apr 26th, 2010 at 02:56:00 PM EST
[ Parent ]
Yes, but the government only exists within the rules set up by other social forces, one of which today is a shared, deep core belief that markets are both the default and preferred way of organizing things.
by santiago on Mon Apr 26th, 2010 at 04:19:11 PM EST
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And people will believe the ones paid by the billionaires with real skin in the game before the government bureaucrats, like they do now in every filed regulated by government ratings and analysis.

"People" and "wealthy investors" can believe whatever they want. The point here is to prevent the banks from counterfeiting, not to prevent market-worshippers from being separated from their money.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 26th, 2010 at 05:15:36 PM EST
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Agreed, but my point is that people willing to risk their money -- including governments in many cases -- will just ignore the cumbersome US government paid rating agencies anyway and go with the private ones, like they do now.
by santiago on Tue Apr 27th, 2010 at 03:39:47 PM EST
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It's possible to pseudo-anonymise the ratings: Have a central database, Alice, where every registered rater and rating agency are assigned random alphanumeric codes, another database, Beatrice, where every report is assigned tied to the alphanumeric codes representing the author(s) and their affiliation(s).

N months after a rating has been issued (where N possibly depends on the type of rating), the rating is compared to the actual reality. This information is then input into the Beatrice database.

The people who run the Beatrice database can then mine the now blinded data for noteworthy patterns. Any suspicious patterns discovered can be analysed independently, and only if they are actually damning is the Alice database contacted for retrieval of the identity of the suspicious author(s) and/or institution(s).

That's roughly analogous to how you'd blind a medical trial. It's not idiot-proof (no system is, and even if it were, the universe is continually working on inventing more creative idiots), and it's certainly not fraud-proof either (no institution in this universe can be made completely fraud-proof), but it would be head and shoulders above what we currently have.

(Assuming you even need rating agencies at all...)

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 26th, 2010 at 05:09:34 PM EST
[ Parent ]

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