Thursday, September 10, 2009

Credit rating agencies and regulation

Interesting nugget from Arnold Kling:
The reality is that it was regulatory policy, not markets, that drove the use of credit agency ratings. Bank regulators, especially with a rule that took effect on January 1, 2002, gave breaks on capital requirements to banks that held assets with AA and AAA ratings from credit rating agencies.
So let's get this straight: the government gave financial incentives to use credit rating agencies, incorporated ratings from these agencies into the calculation of capital requirements via Basel II (thus requiring their usage) and then created an oligopoly in the credit rating market. Is it any wonder that the mortgage market was as screwed up as it was given the integral role played by the rating agencies? The financial crisis occurred in large part because of, not in spite of, regulation.

More broadly, is it any coincidence that those areas of the economy that are in the most trouble -- health care, finance, housing -- are also subject to among the most regulation and government intervention? This would suggest a pattern.

Remember, much of our regulation is premised on the idea that the government -- that is to say, politicians -- have a better understanding of the risks and dangers facing various sectors of the economy than the businesses that operate in them. Without the government to guide them these businessmen would engage in behaviors leading to their own destruction. It's a belief in Lemmings as real-life.

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