Feed on

I’ve just finished reading Joe Stiglitz’s account of the financial crisis.  In it he makes the following comment:

Competition, in this case, had a perverse effect: It caused a race to the bottom — a race to provide ratings that were most favorable to those being rated.

Ughh. I guess being a Nobel Prize winner allows you to change the meaning of competition so that the square peg can be put into your “competition is destructive” round-hole. In this case, Stiglitz is referring to the fact that Moody’s, S&P and Fitch, the three Nationally Recognized Statistical Rating Organizations, ended up marking many securities as “very safe” with a AAA rating because investors really wanted lots of AAA securities to invest in.

Here Stiglitz conveniently leaves out of his story a 1975 decision by the Securities and Exchange Commission (regulators) to confer NRSRO status on the three existing rating agencies at the time, basically granting them an unchallenged oligopoly in credit rating. Further, earlier regulations in 1936 edition of New Deal regulations, forced many securities issuers to obtain credit ratings from said agencies.

So now we live in Stiglitz’s world where cartelization counts as competition. What is next? Is he going to assail the teachers’ unions for competing with each other and that this is the reason public school quality is suffering? The competitive threat that markets rely upon occurs both at the intensive and extensive margins. Stiglitz here focuses only on the intensive margin. These rating agencies faced not a single threat that new agencies could put forth ratings that modeled risks differently, or offered a different way of being compensating than the cartelized NRSRO. Indeed, in this same volume, Jeffrey Friedman summarizes how “disgruntled” workers at S&P and Moody’s, who had concerns about the risk-modeling used in real-estate securities ratings, had no way to act on this information.

And let’s take bets on what Mr. Stiglitz would have been writing had there been real robust competition in the ratings agencies leading up to the crisis. “Why, this competition is destructive for informational reasons too. There would be too many ratings for investors to consider, and therefore we need to limit competition among the rating agencies to make this information digestible.”

It must be nice to live in a world where anything can confirm you view of how the world works. Some of us do recognize that the financial crisis poses problems for our views of markets (for example, despite the regulatory failures, just because it was possible for banks to make huge profits by leveraging up and investing in securities of unknown quality, it does not mean they should do it, does it?), are there folks who would do the same about regulation and government?

Leave a Reply