Kevin Drum

Eating Your Own Dog Food

| Tue Sep. 29, 2009 12:32 PM EDT

Wall Street has a demonstrated aptitude for bundling up and securitizing pretty much anything: mortgages, credit card debt, parking meter collections, naked swaps, bundles of bundles, etc. etc.  So why not put this ability to good use as a way of motivating ratings agencies to care about the accuracy of their ratings?  A reader emails with this elegant suggestion:

Require them to sell collateralized rating obligations. The idea is that they will bundle tranches of ratings together into a form of a put. If the tranche of, say, AAA ratings fail at a rate greater than whatever the published risk of default of the class is, they will be forced to pay a contracted amount to the purchasers.

I like it!  There's no income stream associated with ratings, which is a problem, but surely one that Wall Street can solve.  Instead of paying a fee for getting their securities rated, maybe issuers should instead be required to set aside 0.1% of the income stream from each of their products to be bundled into a Ratings Backed Security.  Agencies would be allowed to sell half the RBS immediately, but would have to hold on to the other half for a set period of time related to the maturity period of the underlying securities.

Or something.  Details are left as an exercise for the reader.  But I like the out-of-the-box thinking here!

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Chart of the Day

| Tue Sep. 29, 2009 11:25 AM EDT

Republicans took their best shot at sinking healthcare reform over August, but it turns out that public support for their position was sort of a like a convention bounce: sharp but short-lived.  At least, that's the takeaway from the latest Kaiser poll, which shows that support for healthcare reform has already recovered from the beating it took during the summer townhalls.  This is pretty much what I expected all along, and I wouldn't be at all surprised to see public support creep back into the low 60s if Obama and the Democrats continue to lower the temperature and work steadily to produce a solid, defensible bill with demonstrable benefits for the average consumer.  With this level of support, healthcare reform is decidedly doable.

Warning: Don't Tease the Prosecutors

| Tue Sep. 29, 2009 10:41 AM EDT

I've managed to avoid blogging about Roman Polanski before now, but I have to admit to sharing some curiosity about the timing of this whole affair.  After all, Polanski has been flitting around Europe for decades and owns a home in Switzerland.  So why did prosecutors in Los Angeles suddenly feel the need to go after him now?  The LA Times thinks it has the answer:

Sources have told The Times that Polanski's attorneys helped to provoke his arrest by complaining to an appellate court this summer that Los Angeles County prosecutors had made no real effort to capture the filmmaker in his three decades as a fugitive.

The accusation that the Los Angeles County district attorney's office was not serious about extraditing Polanski was a minor point in two lengthy July court filings by the director's attorneys.  But the charge caught the attention of prosecutors, who had made several attempts to apprehend Polanski over the years.

Lesson of the day: keep an eye on your lawyers.  Sure, they're clever, but sometimes they can be a little too clever.

The Empire Strikes Back

| Tue Sep. 29, 2009 12:46 AM EDT

Apparently the Vatican has finally decided that the best defense is a good offense.  According to a bellicose statement issued Monday, the Catholic Church doesn't have a paedophilia problem, it has an ephebophilia problem, thankyouverymuch.  Plus this:

The statement, read out by Archbishop Silvano Tomasi, the Vatican's permanent observer to the UN, defended its record by claiming that "available research" showed that only 1.5%-5% of Catholic clergy were involved in child sex abuse.

He also quoted statistics from the Christian Scientist Monitor newspaper to show that most US churches being hit by child sex abuse allegations were Protestant and that sexual abuse within Jewish communities was common.

Only 1.5-5%!  Not bad!  And anyway, Protestants and Jews are doing it too.  So there.

Admittedly, I'm not a theological expert, but to my ears this sounds only slightly more sophisticated than something you might hear from a red-faced five-year-old.  Augustine must be spinning in his grave.

Fixing the Ratings Agencies

| Mon Sep. 28, 2009 9:03 PM EDT

Matt Yglesias comments on the packaging of crappy loans back in the heyday of the credit bubble:

The mysterious thing isn’t that people made bad loans that they were able to package and sell off, the mysterious thing is that they found buyers for the securities.

Ultimately this looks to me to go back to the ratings agencies, an issue [Barney] Frank sort of dodged. But the ratings agencies are private for-profit companies that also enjoy a kind of government-sponsored monopoly status. In theory their behavior should be subject to market discipline, but in practice it’s not. They screwed up badly. But while lots of companies have gone bankrupt and lots of people have lost their jobs, the ratings agencies are all still in business. And no new competitors are coming to the fore and there’s no real way for anyone to break into the industry.

No question about it: over the past decade ratings agencies were, at best, negligent, and at worst, perpetrators of outright fraud.  "It could be structured by cows and we would rate it" is surely one of the all-time great quotes of the bubble era.  And the fact that agencies shared their models with issuers so they'd have an easier time tweaking their products to get high ratings is prima facie evidence of corruption.  Slapping a AAA rating on every cobbled-together junkpile that slithered its way out of a Wall Street structured finance group certainly helped fuel the fantastic expansion of risky investments that all came crashing down in 2008.

Still, I have to admit that over the past year ratings agencies have moved down my personal league table of bad actors.  If you take a look at the list of possible causes for our recent financial meltdown here, I probably would have put the ratings agencies in the top five a year ago, while today I'm not sure I'd even put them in the top ten.

Partly this is because I've become more sympathetic to fundamental macroeconomic explanations for the bubble: easy money, current account imbalances, massive abuse of leverage, and huge increases in both debt and risk that were masked by ever more baroque credit derivatives.  Partly it's because widely accepted1 risk models based on CDS spreads mostly produced the same results as the ratings agencies.  Partly it's because the negligence/fraud involved in producing high ratings was pretty clearly a two-way street: buyers and sellers of structured investments were every bit as anxious to get them as the ratings agencies were to provide them.

Beyond that, I'm also a bit flummoxed about what the answer to the ratings agency problem might be.  There's probably a reasonable regulatory solution for fraud and negligence, but there seems to be wide agreement that the real problem is incentives: since issuers are the ones paying for ratings, it's inevitable that agencies are going to lean into the wind to provide ratings the issuers like.  I've read dozens of proposals for ratings agency reform, but the only one that really gets at this fundamental conflict-of-interest problem is to simply do away with them and turn debt rating into a government function.  I'm a little skeptical of that, though, since it's not at all clear to me that a government agency could hire the kind of talent it takes to keep up with Wall Street's rocket scientists.  What's more, it's not at all clear to me that anyone — Fed regulators included — would have rated SIVs much differently during the boom years than the ratings agencies did.

So....I'm not sure what the answer is.  Tighter regulation would obviously be welcome, but how do we get rid of the underlying conflict-of-interest problem?  How do we align agency incentives in favor of long-term accuracy?  How do we encourage real competition between the agencies, rather than a race to the bottom?  None of the regulatory reforms I've seen really get at this in a fundamental way.  Does that mean that a government takeover is the only real answer?  Or does it mean that there is no real answer and we've collectively decided to shrug our shoulders and allow this to happen all over again in a few years?  Somebody should ask Barney Frank.

1Whether they should have been widely accepted is a different question.  But they were.

800 Years of Financial Folly

| Mon Sep. 28, 2009 6:00 PM EDT

Carmen Reinhart and Kenneth Rogoff have done something that, apparently, no one has done before: rigorously collect data on debt and risk management (or lack thereof) over the past 800 years, rather than only since 1980.  Their conclusion: excessive debt accumulation is always and everywhere a very, very bad thing.

Also: credit booms and busts happen over and over throughout history, with only the details changing; public sector debt crises are common and devastating; banking crises hit every country, rich and poor alike; and when credit bubble pop, everything pops along with it.  And finally, a fifth lesson, as summarized by Martin Wolf:

The final lesson is that financial liberalisation and financial crises go together like a horse and carriage. It is no surprise, therefore, that the last 30 years have seen waves of financial crises, of which the latest one is merely the biggest. The current crisis is the worst since the Great Depression. Yet, argue the authors, no one should have been surprised by this outcome. The US showed all the classic symptoms of a country heading for crisis: a huge current account deficit; soaring house prices; headlong credit growth; and, let us not forget, excessively complacent regulators.

It always comes back to debt and leverage, doesn't it?  There are lots of other things to watch out for too, but the bottom line is that if you keep leverage at reasonable levels, your financial crises are likely to be manageable.  If not, not.  Tim Geithner, please take note.

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Assignment Desk Watch

| Mon Sep. 28, 2009 1:07 PM EDT

If the New York Times is serious about its shiny new plan to cover the conservative noise machine more thoroughly, they better jump on this one right away.  By tomorrow it will probably be gone, yet another important story missed by the mainstream media.  Get cracking, guys.

The Case of the Missing Documents

| Mon Sep. 28, 2009 12:44 PM EDT

Two years ago the ACLU filed a request for records about torture and detainee abuse.  Part of what they got was a list of 181 documents the government considered exempt from release.  But when the feds took another look this year, they couldn't find ten of the documents on the original list.  What happened?  Nick Baumann speculates:

"It was impossible to ascertain whether the discrepancy was the result of an error by the prior administration when it created the original...index or whether the prior administration misplaced the documents in question," Tracy Schmaler, a Justice Department spokeswoman, told Mother Jones. In other words, CIA and Justice Department lawyers might have mistakenly listed documents that never existed in the first place.

But is it plausible that the inconsistency could be merely a clerical error? After the Bush administration created the index, a CIA official swore under oath that she had reviewed the documents on the original list. And one of the disputed documents was listed on the original index as a 46-page memo "providing legal advice," classified as top secret and dated 25 July 2002. Schmaler says the Obama administration's search never found a document matching that description. Could the CIA and Justice Department lawyers who composed the original list have mistakenly included a non-existent memo — complete with a date and precise page count?

Well, maybe there were two 46-page memos written on 25 Jul 2002.  Or, um, maybe it was actually a memo about restraining booze, not detainee abuse.  Or something.  I'm sure it will all be cleared up soon.  Move along folks.  Nothing to see here.

The Third Rail

| Mon Sep. 28, 2009 12:04 PM EDT

Conor Friedersdorf comments on Glenn Beck's recent heresy that a McCain presidency might have been even worse than an Obama presidency:

It is therefore no surprise that Comrade Beck is now being turned on by Comrade Limbaugh and Comrade Levin (the one among the trio who actually believes most of what he says)....

Well, Levin might believe most of what he says, but I was at Blockbuster the other day and found myself thumbing through a copy of his recent bestseller, Liberty and Tyranny(Why does Blockbuster now sell books?  That's a question for another time.)  To my surprise, it turns out that for all his bombast, Levin is a wimp.

The end of his book is taken up by a "conservative manifesto," and it's chock full of fire-breathing stuff.  Eliminate the income tax, eliminate corporate taxes, put a hard cap on the size of the federal government, eliminate tax-exempt status for all environmental groups, rein in judicial review, insist on originalism as the only proper way to interpret the constitution, make governments pay property owners for all zoning changes that affect them, wipe out all teachers unions, no national healthcare, crank up military spending, put God back in government, etc. etc.  I'm paraphrasing a bit, but you get the idea.  It's hardcore right-wingerism.

Obviously, then, a guy like this wants to do away with Social Security and Medicare, right?  Well, hold on there, pardner.  Let's not go off half-cocked.  Sure, they're "poisonous snake oil," but all Levin can bring himself to suggest is that young people be educated about the intergenerational "trap" of entitlements so that they can be "contained, limited, and reformed."  Educated!  Limited and reformed!  That's it.

Pretty weak tea for a firebreather.  Even among the wingers, it turns out, Social Security is a third rail.  After all, I guess Levin wants old people to buy his book too.

Who Benefits From Medicare Advantage?

| Mon Sep. 28, 2009 10:44 AM EDT

When Congress passed the Medicare prescription drug plan in 2003, it provided two ways for seniors to get access to pharmaceuticals: they could enroll directly in a prescription drug plan or, via Medicare Advantage, they could enroll in an HMO that offered drug coverage.  Medicare Advantage, of course, has long been controversial because the government provides subsidies to HMOs to participate, which means that it's more expensive to taxpayers than standard Medicare.

Still, Medicare Advantage enrollees enjoy extra benefits.  The program also provides incentives for HMOs to enter new areas and compete with each other.  So it's not as if the subsidies are being completely wasted.

But it does turn that they're being mostly wasted.  Austin Frakt, a health economist at Boston University, provides the dismal numbers:

My work (with Steve Pizer and Roger Feldman) shows that for each additional dollar spent by the federal government (taxpayers) on the program since 2003, just $0.14 of it can be attributed to additional value (consumer surplus) to beneficiaries....

What do we make of the other $0.86? That goes to the insurance companies but doesn’t come out “the other end” in the form of value to beneficiaries. In part it pays for the additional benefits themselves and in part it is captured as additional insurer profit.

Conversely, standard prescription drug plans provide more than a dollar of benefit for each dollar spent.  Roughly speaking, these plans cost taxpayers about 75 cents for each dollar of value they provide.

Bottom line: if healthcare reform cuts back on Medicare Advantage, the effect on retirees would be tiny.  Putting even half of the cuts back into standard prescription drug plans would almost certainly make everyone better off except for insurance companies.  The full paper is here.