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Thursday, October 08, 2015

Wanted: Independent Evaluations of Government Programs

In case you are feeling Moody:

Timothy Geithner and the Auditors, by Dean Baker: Eduardo Porter had a good piece in the NYT pointing out the importance of having independent evaluations of government programs. The point is that the agencies undertaking a program have a strong incentive to exaggerate its benefits. ...
One of the areas noted by Porter is in the rating of mortgage backed securities (MBS). During the housing bubble years, the bond-rating agencies routinely gave investment grade ratings to MBS that were stuffed with junk mortgages. They ignored the quality of the mortgages because they wanted the business. They knew if they gave honest ratings, the investment banks would take away their business.
While Porter notes this is a problem with the issuer pays model (the banks pay the rating agencies), there actually is a very simple solution. In the debate on Dodd-Frank, Senator Al Franken proposed an amendment which would have the Securities and Exchange Commission pick the rating agency, instead of the issuer. The bank would still pay the fee, but since they were no longer controlling who got the work, it eliminated the conflict of interest problem. The amendment passed the senate 65-34, with considerable bi-partisan support.
Unfortunately, as Geithner indicated in his autobiography, the Obama administration apparently did not like the dismantling of the perfect system we have today. The Franken amendment was removed in the conference committee and the existing structure was left in place. This was possible because the bond-rating agencies and the banks have real lobbies, whereas the folks who like honest evaluations don't. Of course the news media didn't help much, giving the issue very little coverage. And what attention it did get largely reflected the views of the financial industry.
Anyhow, this is a good example of the difficulties in putting in place the sort of independent auditing process that Porter seeks.

    Posted by on Thursday, October 8, 2015 at 10:53 AM in Economics, Politics, Regulation | Permalink  Comments (47)


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