Monthly Archive for January, 2010

David Goldman has the experience (and smarts) to make his recommendations credible. How do we achieve the level of transparency that will prevent ratings-agency-capture? Here are David’s bullets, which make sense to me:

The fact is that there are plenty of good risk models out there. The Moody’s analysts cited in the story above knew perfectly well what they were doing. The way to fix the problem is to rate risky securities with full transparency.

Here’s how to do it:

1) Require large financial institutions to provide their internal data for default and delinquency. The big banks have long histories of default with a great deal of detailed characteristics of defaulting companies.

2) Create a publicly available, downloadable data set with the merged data (suitable sanitized to remove company names, but including detailed borrower data such as balance sheet, sales, capital structure, and so forth.

3) Charge the Federal Reserve staff with constructing empirical default models to predict defaults based on company histories as well as market observations (my old favorite its the implied volatility of options on the stock of publicly traded companies).

4) Publish the Fed’s model along with the data set.

5) Convene an annual conference to allow academics and private analysts to critique the Fed’s model, so that the Fed staff has to answer to extensive criticism.

6) Use the Fed model to establish reserve and other risk criteria for securities.

7) Allow the private sector to take the same data and sell alternative risk models to investors who think that private analysts might do a better job than the Fed staff.

On the strength of transparent and universally accessible data, criteria can be established for capital adequacy of large banks.

By making the process open to any academic or commercial contender, the corruption inherent in the ratings process is eliminated.

This, of course, would pretty well kill the business of the ratings agencies. They should feel fortunate to get off so easily.

We don’t want to stop the banks from investing for their own account. In market panics, we want big institutions with broad shoulders to step in and buy securities that other investors are forced to sell. But we want this to happen in full light of day, in a way that the regulators and investors can understand.

Please continue reading Inner Workings.

Ilya Somin fact checks the American president:

In the State of the Union, Obama continued to blame Bush and the Republicans for our current economic problems.

(…) The Bush as free marketeer meme is an important prop in the Democrats’ case for massively expanding government control of the economy today. Logically, of course, it is possible to argue for such an expansion even if Bush did it too. Maybe he just didn’t go far enough, or didn’t calibrate his interventions as precisely as the Democrats plan to with theirs. From the standpoint of political rhetoric, however, it’s much easier for Obama to justify greatly expanded government if he can portray it as the opposite of his discredited predecessor’s policy. The gambit probably wouldn’t work if the public knew the facts about what Bush did. Obama, however, may be banking on widespread political ignorance, reinforced by the GOP’s image as the pro-free market party. He is far from the first politician to try to take advantage of ignorance. The Republicans have hardly been above doing the same thing when it suited their interests. But the fact that everyone does it doesn’t make it right.

Please continue reading…