Michael Lewis' excellent The Big Short answers one of the big questions surrounding the 2007-8 financial crises: where were the ratings agencies?
Clearly, they failed. But in this light, they failed in a predictable way. Consider similar examples:
Public servants: regulatory bodies and elected officials are supposed to be neutral arbiters of the public interest -- but we can observe the huge pay bump of Congresspeople when they stop running for office and go to work for lobbying firms, and the regulatory capture of agencies by the institutions they are supposed to regulate.
Journalists: they are supposed to figure what "all the news that's fit to print" is and report it accurately. But because the money's better, journalists are increasingly becoming PR people whose job it is to push decidedly non-neutral storytelling.
Google: it is supposed to direct you to the most important and relevant articles on the Internet. In response, content farms and search engine optimization have sprouted up to get website owners better placement on searches -- essentially gaming the system.
What factors enable pushback against institutional capture?
What struck Eisman immediately - and what struck Danny and Vinny, too - was the caliber of their employees. "The ratings agency people were all like government employees," said Vinny. Collectively they had more power than anyone in the bond markets, but individually they were nobodies. "They're underpaid," said Eisman. "The smartest ones leave for Wall Street firms so they can help manipulate the companies they used to work for."
Wall Street bond trading desks, staffed by people making seven figures a year, set out to coax from the brain-dead guys making high five figures the highest possible ratings for the worst possible loans. They performed the task with Ivy League thoroughness and efficiency...To understand better what's going on here, we should think about the stated purpose of ratings agencies: to act as neutral arbiters of truth, evaluating the default risk of various bonds.
Clearly, they failed. But in this light, they failed in a predictable way. Consider similar examples:
Public servants: regulatory bodies and elected officials are supposed to be neutral arbiters of the public interest -- but we can observe the huge pay bump of Congresspeople when they stop running for office and go to work for lobbying firms, and the regulatory capture of agencies by the institutions they are supposed to regulate.
Journalists: they are supposed to figure what "all the news that's fit to print" is and report it accurately. But because the money's better, journalists are increasingly becoming PR people whose job it is to push decidedly non-neutral storytelling.
Google: it is supposed to direct you to the most important and relevant articles on the Internet. In response, content farms and search engine optimization have sprouted up to get website owners better placement on searches -- essentially gaming the system.
What factors enable pushback against institutional capture?
- Having market power: In other words, being monopolistic.
Traditional newspapers used to derive revenue from their near-monopolies on local print advertising markets. They could then afford to develop a reputations for accuracy. With fewer moats against competitors, less-profitable new media like Gawker, HuffPo, and BusinessInsider are far easier to capture.
- Being well-organized: Google and the US Congress are both essentially monopolistic institutions, but one is much better organized.
Google quickly and painlessly changed its algorithm to downgrade content farms. But Congress -- short of an actual bribery conviction -- has little incentive and few mechanisms to punish transgressors. The aptly named Congressman Weiner's continued to disgrace his office for almost two weeks on the front page before yielded to pressure to resign.
