The Obama Administration’s 89-page report on financial regulatory reform says on page 3,
Market discipline broke down as investors relied excessively on credit rating agencies.
To me, attributing the use of credit rating agencies to a breakdown in market discipline undermines the credibility of the report. Instead, one cannot ignore the role played by regulators.
—Mark Flandreau and Norbert Gaillard describe regulatory use of rating agencies in the 1930’s. (thanks to Mark Thoma for the pointer.)
in 1931, in the midst of extensive fire sales of assets that threatened banks’ solvency, US authorities decided that banks supervised by the Comptroller of the Currency (the supervisory body that was in charge of dealing with so-called national banks in the US) would be enabled to book investment-grade securities at face value rather than at market price.
–in 1975, regulators created the official designation of Nationally Recognized Statistical Rating Organization, effectively setting up the credit rating agencies as a government-sanctioned oligopoly
–in January of 2002, the major U.S. bank regulators issued a policy allowing banks to hold less capital based on high grades issued by the credit rating agencies.
READER COMMENTS
fundamentalist
Jun 26 2009 at 4:13pm
Neither asleep-at-the-wheel regulators, not greed caused the crisis. Hubris and bad macro and monetary theory did. The excerpt below is from “The Recession-Causes and Cures” pp 13-14 by David Simpson of the Adam Smith Institute:
“These conditions resulted in a period of disinflation – a slowdown in the rate of
increase of the prices of goods and services.8 Disinflation helped to usher in a
feeling of confidence, first amongst policymakers and later amongst financial market
participants, that a new and permanent era of financial stability and economic
wellbeing had been achieved. It was known to believers as the ‘New Paradigm’.
In his Presidential address to the 2003 meeting of the American Economic
Association, Robert Lucas said that the “central problem of depression prevention
has been solved, for all practical purposes.” A year later, Ben Bernanke, soon to be
appointed to succeed Alan Greenspan as Chairman of the Federal Reserve Board,
gave a speech entitled ‘The Great Moderation’. Like Lucas, he argued that modern
macroeconomic policy had solved the problem of the business cycle, or at least had
reduced it to the point that it was no longer a major concern.”
“This orthodox view, which is held by neoclassical monetarists and Keynesians alike,
is unbalanced in two important respects. It does not acknowledge the significance
of the ‘boom’ phase of the boom and bust cycle – indeed, it does not acknowledge
its existence at all. And, secondly, it believes that the ‘bust’ phase is purely the
result of a deficiency of aggregate demand. Nevertheless, it is a view that appeared
to have been vindicated by recent events. The Fed had responded to the financial
crises of 1987, 1991 and 2001 by flooding the financial markets with money,
and the subsequent recessions in real activity were either short-lived or avoided
altogether. These apparently successful policy responses added to the belief that
the Western world had entered a New Paradigm of financial stability and economic
prosperity. They also laid the foundations for later disaster by fixing in the minds
of financial market players the belief that that no matter what you did, the central
bank would bail you out.9”
“It was widely believed by central bankers, Treasury officials and their advisers on
both sides of the Atlantic that this new era of financial stability, low inflation, steady
growth and low unemployment would last forever, not appreciating that it was the
result of transient historical forces that had already begun to disappear by the time
the first tremor was felt in the financial markets in August 2007.10” http://www.adamsmith.org/images/stories/the-recession.pdf
cputter
Jun 27 2009 at 10:41am
It’s ridiculous for the government to blame it on the rating agencies when government regulations gave those 3 rating agencies a bloody monopoly…
Neil D
Jun 27 2009 at 1:19pm
When are we going to stop picking on the regulators? They did exactly what we wanted them to do. And stop blaming the ratings agencies too.
Every person who obtained a mortgage in the last 8 years is to blame. Every person who drew on home equity lines of credit is to blame. The regulators, ratings agencies, and everyone else were serving those looting their real estate holdings to buy new cars and take great vacations.
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