Cause of the Financial Collapse
The Democrats are simply wrong. One of the reasons we are in this mess is because of too much regulation. Here several examples.
- President Kennedy allowed forced collective bargaining of public unions which eventually drove cities and states to fiscal ruin.
- The Fed micromanages interest rates and that was a huge factor in creating the housing bubble. Note the Fed was created as a result of government regulation.
- Congress had hundreds of affordable housing programs including Fannie Mae and Freddie Mac. Affordable housing programs and lending mandates such as the Community Reinvestment Act also contributed to the housing bubble
- The SEC anointed Moody's, Fitch, and the S&P as "Nationally Recognized Statistical Rating Organization (NRSRO)". Once again this regulation came back to bite years later when the ratings agencies labeled pure garbage as "AAA"
Time To Break Up The Credit Rating Cartel
Let's take a closer look at point number four. I discussed the ratings agencies in depth in Time To Break Up The Credit Rating Cartel
The rating agencies were originally research firms. They were paid by those looking to buy bonds or make loans to a company. If a rating company did poorly it lost business. If it did poorly too often it went out of business.
Low and behold the SEC came along in 1975 and ruined a perfectly viable business construct by mandating that debt be rated by a Nationally Recognized Statistical Rating Organization (NRSRO). It originally named seven such rating companies but the number fluctuated between 5 and 7 over the years.
Establishment of the NRSRO did three things (all bad):
1) It made it extremely difficult to become "nationally recognized" as a rating agency when all debt had to be rated by someone who was already nationally recognized.
2) In effect it created a nice monopoly for those in the designated group.
3) It turned upside down the model of who had to pay. Previously debt buyers would go to the ratings companies to know what they were buying. The new model was issuers of debt had to pay to get it rated or they couldn't sell it. Of course this led to shopping around to see who would give the debt the highest rating.
With that I have to sit back and laugh at one of the original opening statements in this article: "I do not think that the market can discipline ratings agencies sufficiently," said Mr Mindich, chief executive of Eton Park Capital and a former colleague of Hank Paulson, the Treasury secretary, at Goldman Sachs, the investment bank.
Clearly Mr. Mindich does not understand the free market. The problems arose because the free market was disrupted by a misguided mandate by the SEC.
The Solution is Amazingly Easy
Government sponsorship of organizations and intervention into free markets always creates these kinds of problems. The cure is not an executive shuffle, third party verification or half-measures and more regulation that mask over the issues by splitting functions within an organization. The SEC created this problem by creating the NRSRO. The problem is easily fixable. It's time to break up the cartel by eliminating the rules that created it. Moody's, Fitch, and the S&P should have to sink or swim by the accuracy of their ratings just like everyone else. Ratings would be a lot better if corporations had to live or die by them. Free market competition, not additional regulation is the cure.
Many point to elimination of Glass-Stagall as the cause of the crisis. They are wrong. Glass-Steagall would not have stopped the securitizion process or passing the trash to Fannie Mae or investors. It would not have stopped the AAA rating scam of Moody's, Fitch, and the S&P.
A case can be made for Glass-Steagall on the grounds that separation of duties wouls prevent fraud, and regulations designed to preserve property rights and prevent fraud are reasonable. However, Glass-Steagall would have done nothing to stop the housing bubble or subsequent crash.
The key point is government regulation, the Fed, and fractional reserve lending are the primary causes of numerous boom-bust cycles.
Regulation should focus on fraud prevention and preservation of property rights, not misguided social agenda like "affordable housing". Government never makes anything affordable.
Mike "Mish" Shedlock