Is The Free Agent the only one who heard President Obama channeling Edward G. Robinson at his speech at Cooper Union last week? ‘Listen here, you mugs,’ she paraphrases, ‘You’re gonna get in line, see? You’re gonna play by the rules, and guess who’s gonna be making the rules?” Underlying the current reform fad is the misconception that it is even possible—that a handful of elected officials or bureaucrats can have so much knowledge and wisdom that if only given enough power, we’ll all find ourselves richer, healthier, whatever-ier. In other words, support for government reform of industry (rather than itself!) is support for the myth of the benevolent and wise dictator. But The Free Agent herself has wondered on occasion, how could major fragility—the hollow core of Enron, for example—in financial markets be completely obscured? Doesn’t that argue against market discipline as the most effective agent of honesty and prosperity, and suggest dictatorship by the few might be better?
A tip-toe through the history of an atom-thin wedge of financial regulation, the SEC’s involvement with bond-rating agencies, may illuminate how useless at best, toxic at worst, intervention can be.
John Moody issued the first publicly available bond ratings in 1909, and several other firms followed, offering their analyses to potential investors. By the 1940s, banks, insurance companies and broker-investors were limited by regulators to purchasing “investment grade” (BBB or better) bonds. Whose ratings were acceptable would be determined by the SEC, the three extant firms—Standard & Poor’s, Fitch, and Moody’s—were automatically blessed, and potential competitors would have to navigate the SEC’s mysterious approval process.
During the 1970s, an “information wants to be free” crisis threatened the ratings companies. Their customers had been potential investors, who could subject inaccurate ratings to good ol’ market discipline, but because information could be disseminated so cheaply once it had been collected at great expense, all three firms changed their business model to collect their fees from bond issuers instead of potential investors. The potential conflict of interests and opportunity for corruption (in order to sell my bonds to institutional investors, I must have an investment grade rating, but fortunately, I’m the one paying a company to rate me, so . . .) were only obscured by the SEC’s “oversight” and effective monopoly power over ratings agencies. Between 1975 and 2000, only four more ratings companies had been blessed by the SEC, but because of consolidations, in 2000, the big three were again the only game in town if you wanted your debt rated. A week before Enron declared bankruptcy in 2001, Moody’s and S&P still rated its debt investment grade.
The Credit Rating Agency Reform Act of 2006 was a now-familiar excuse to use a problem created by regulation to justify further regulation (there are now ten ratings companies blessed by the SEC, which The Free Agent supposes must be better than three, but not as good as “anyone who can do a better job”).
Investors would be better served by having to research their own decisions or buy information from a company they judge credible, rather than—and the word The Free Agent hates in this context rears its head once more—trust the SEC to make that judgment for them.
The thumbnail version of the President’s speech is this: “Okay Wall Street, we’re all gonna get rich, but instead of winning over Main Street, you’re just gonna deal with Pennsylvania Avenue, see?’