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On the origins of the 2008 financial crisis

This isn't a local issue – more of a global one, that I post here only because I think we may get close to some of the origins of the financial crisis that is causing such widespread disruption. These are the view's of one man, a Moody's insider.


I've just come across this submission of just a few days ago, to the Securities and Exchange Commission by a former Moody's man.

The credit ratings agencies have come in for some attention as a factor in the October 2008 financial meltdown. It shows the pressure that analysts were under from their management and from banks to give favourable ratings to financial instruments.


Comment on SEC proposed rules for Nationally

Recognized Statistical Rating Organizations 

Link to 712 kb PDF file

Views: 51

Tags: agencies, banks, credit, crisis, financial, ratings

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Comment by Clive Carter on August 21, 2011 at 8:45

Adrian: a good summary. Perverse incentive indeed. The credibility of credit ratings agencies has taken something of a blow due to the exposure of massive conflict of interest.

At the local level, its equivalent to a consultant being employed (i.e. highly renumerated) by the local council to "independently" assess the merits of a council magazine and whether or not that magazine is the public's preferred way of receiving communications from the council.

At the macro level, the conflicts of interest of credit ratings agencies assisted billions of dollars of investment monies (such as pension funds etc) going into debt instruments that should never have enjoyed the high assessment accorded them by the ratings agencies.

The best way to deal with conflicts of interest is not to have them in the first place.

Comment by Adrian Essex on August 21, 2011 at 7:45

This paper is a submission by a former employee of Moody's to the Securities and Exchange Commission, making comment on some proposed rule changes for the oversight of ratings agencies by the SEC. In so far as they affect Moody's he says that the changes would only make matters worse, since their impact is to reinforce management  control over analysts  opinions. Management is a group of people required to deliver value to Moody's shareholders. Analysts are a group of people supposedly capable of understanding the risks associated with different types of investment. Moody's only makes a profit if it issues opinions that its customers want to hear. For the years prior to the crash Moody's continued to publish positive opinions on assets which did not continue to be worthy of those opinions.

He identifies a set of perverse incentives to publish unwarranted opinions during the boom years, which the proposed changes will do nothing to remove. He asserts that analysts held one opinion of assets in private, but were forced to offer management friendly opinions in public.

He casts doubt on the deferred payment method of rewarding employees which is now being touted as a cure for some of banking's ills in this country. The theory is that if staff are paid in share options exercisable in the future, they must have the good of the company at heart. This is supposed to be an improvement over bonuses paid in cash each year, whereby staff need have only their own immediate gains to consider. In the case of Moody's the share options approach simply led to long term distortion of analysts opinions, which in turn led to the house of cards, which has now collapsed.

I think the "perverse incentive" approach has a very wide application today. 

For instance, British Banks are now repaying premiums collected for Payment Protection Insurance (PPI). This insurance was sold because the banks, as corporate entities, had an incentive to sell insurance, rather than having an incentive to ensure that their clients had the correct insurance.

For another instance, examination boards have, since their privatisation, had an incentive to produce examinations which schools want to buy, rather than examinations which test the knowledge of the examinees. Schools have an incentive to achieve very high pass rates, rather than to educate all their pupils across a broad range of subjects.

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