Posts Tagged ‘global economy’


There were many perpetrators involved in the 2007-09 financial crisis and most of them have gotten off scott free. Credit rating firms were a major player that have experienced limited fallout for their role in creating and exacerbating the global financial crisis.

And now it looks like despite a 3-year old Congressional directive for the Federal Securities and Exchange Commission to alter credit rating industry’s business model in which a bond issuer pays for the credit rating, little or nothing will actually be done to change how the industry works. So reports The Wall St. Journal.

This is very unfortunate for a couple of reasons:

  1. An inherent conflict of interest and lack of transparency for investors means that it will be difficult to judge the accuracy of credit ratings on a variety of debt instruments.
  2. The potential for another bubble, which could contribute to another global financial crisis.

The model in which an issuer pays a credit rating agency is inherently flawed because the rating agencies have a financial stake in making their clients happy by assigning the highest rating possible, regardless of the merits of the issue in question. This happened en masse during the housing bubble, when all sorts of questionable mortgage backed securities received top ratings.

Many of those issues later experienced extremely high levels of default, which was a “key cause” of the financial crisis, Congress concluded. Duh.

The SEC conducted a day-long meeting yesterday to get advice from experts about what to do about this problem, but hasn’t said what, if anything, they plan to do with this information. I mean, at this point, what more information do they need?

If they do the right thing, in a few months we’ll see some proposed rules that will change how ratings firms are compensated. If not, nothing will change. Of course, the ratings agencies are firmly in favor of the status quo because it would upset their very profitable apple cart if they had to be paid by investors or supervised more closely.

In the meantime, the U.S. Justice Dept. has somewhat tardily sued S&P — but not Moody’s, the other major ratings agency — for fraud, accusing the company of inflating ratings to gain more business during the real estate bubble. It cites 30 deals in which S&P rated collateralized debt obligations that included bundles of subprime mortgages, most of which fell steeply in value after they were sold to investors.

According to the Wall Street Journal, the Justice Department suit alleges that S&P “knowingly and with the intent to defraud, devised, participated in and executed a scheme to defraud investors.” The Justice Dept.  is seeking $5 billion in what would be the largest fines imposed on any firm for actions during the financial crisis.

S&P has filed to have the case dismissed, saying that the firm is being targeted for failing to foresee the financial crisis and bursting of the housing bubble.

On another front, S&P and Moody’s recently settled civil cases brought by investors. The firms were accused of “negligent misrepresentation” regarding their ratings of several structured investment vehicles.

What does all this mean to you and me? That another one of the major players in the global financial crisis may get off scott free and that a big part of the system that led to the crisis may go on  its merry way, completely unchanged. We can only hope that the SEC may actually do something and that failing that, the Justice Department will get some justice in it’s suit against S&P. Stay tuned…

As a deficit reduction and economic policy, austerity never made any sense. It’s ridiculous to think that by cutting budgets in a time of economic recession, you can shrink budget deficits in the future, ultimately increasing economic growth. The policy defied common sense; unfortunately, the powers-that-be fully embraced it, to the misery of countless millions in Europe and here in the U.S. I’ve written about it previously, in a post two years ago entitled Austerity = Suffering and last year, Greece brutalized by more austerity.

Despite the evidence, these powers-that-be have continued to stubbornly cling to this failed policy, imposing it on more countries (Cyprus anyone?), sharing the misery with countless millions more. And finally, concrete evidence has emerged that points out serious flaws in the economic research that underpinned austerity, driving what one hopes is a final stake in the heart of this nonsensical and destructive policy.

As pointed out yesterday in the Roosevelt Institute’s blog The Next New Deal by Mike Konczal, known as @Rortybomb on Twitter, original austerity research basically twisted the facts using selective data and unconventional weightings to reach a flawed conclusion. Rather than forcing economic growth downward, higher budget deficits (for countries carrying a debt-to-GDP ratio of more than 90 percent) produce an average 2.2 percent GDP rate not the .1 percent cited in the original research.

As Konczal notes, “The debt needs to be thought of as a response to the contingent circumstances we find ourselves in, mass unemployment, a Federal Reserve desperately trying to gain traction at the zero lower bound, and a gap between what we could be producing and what we are.” Exactly! When an economy is on it’s knees, stimulus spending, even when it creates significantly higher deficits, is needed to bring it to it’s feet again. Then, once the economy has recovered, deficit reduction efforts, can, and should resume. And when they do, they will be more productive and effective, because they will be in the context of a healthy economy, which will contribute the efforts. See the Clinton years.

By depriving an economy of stimulus during hard economic times, it is doomed to exist in a sub-basement of economic recession, if not depression (see Ireland, for example) that will actually increase deficits. The austerity mindset reacts to these higher deficits with even more austerity, creating a vicious cycle which makes it incredibly difficult for an economy to gain any positive traction and causing untold suffering to millions who lose their jobs and are forced to live on the margins.

Beyond the substantiative problems of this research, Matt O’Brien, aka Obsolete Dogma on Twitter, in an article “The Great Debt Delusion: How Math Keeps Proving Austerity Wrong” notes that what is equally astonishing is how such a “shoddy” piece of research gained such a following in public policy and political circles. It’s depressing that so much misery has been inflicted on so many people based on a misguided, flimsy policy.

The question is whether these revelations will actually do anything to dissuade those who pursue them with so much vigor. I’m guessing not, which means it is the responsibility of the electorate here and in Europe to show them the door.

For true reformation of the financial system to take place, be effective and enforceable, it’s got to happen at the international level. Otherwise, banks and financial services companies can just do an end-run around it by moving out of the country.

While reforming the financial system in the U.S. boggles the mind — and, has yet to happen in any meaningful way — international reform presents a far bigger hurdle. At stake are issues of national sovereignty, national corporate interests, national and individual political ambition and the ability or lack of ability to subordinate all of these interests to the greater good. And that’s assuming agreement as to what the greater good requires, which will likely never happen.

I wrote about this for the now-defunct New York Society of Security Analysts journal, The Investment Professional in the Fall of 2009: Mending the Seams: International Regulatory Reform. In looking back over that story, not much has changed. Actually, maybe it has, for the worse. Because any momentum and willingness to reform has completely dissipated, at least from what I can see.

It’s back to business as usual, and that’s a shame, because we’re courting, at the very least, another financial crisis. Which could be worse than the last one. At least it will likely be different, which may be entertaining on some level, though no doubt devastating to millions of consumers who are barely making it financially right now.

That’s the other problem: the difficulty for regulators, even assuming agreement at the international level, is the tendency for the financial industry and the technology to always be one step ahead of regulators. Because when it’s an unknown unknown — in terms of where the next problem will occur — it’s difficult to address, even with the best will in the world. That’s tough even for known knowns, as Donald Rumsfeld would say, let alone known unkowns and unkown knowns.

Of course, we can argue that the last crisis was eminently foreseeable and preventable. A bubble inflated, regulations were either non-existent or ignored, problems reached critical mass and spread around the globe and the Fed, governments etc did what they thought they had to do to keep the global economy from catastrophe. Those actions are setting the stage for future problems, along with a very troubling lack of will to reform and to prosecute the offenders from the last crisis.

There’s also a compelling argument that there’s been an enormous expansion of high-risk lending on the part of retain bankers, including mortgages, corporate lending and personal loans. With governments around the world on the hook for guaranteeing deposits, the stage is set for another gigantic mess.

With a deposit guarantee, there’s no restraint on the bankers’ tendency to take big risks. Why should bankers restrain themselves? They know they are going to get bailed out. And what happens when the citizenry balks at bailing out these reckless retail bankers? Iceland, anyone?

And who are the real victims? The people who have lost their homes and the taxpayers who are on the hook for the millions of dollars, Euros and Pounds guaranteed by governments. As Frances Coppola points out (thanks to her for the ideas in these last few paragraphs) it’s a systemic problem.

Here are some links on point (some are dated, like my article, but still relevant):

  • The worm in the apple: what went wrong in retail banking Frances Coppola explains the real reasons behind the financial crisis (reckless retail bankers plus lack of regulation plus government deposit guarantees) and why there is no easy answer. However, there is an answer because it is possible (thought not likely IMHO) to break the link between bank lending and economic growth. Follow Frances on Twitter if you’re interested in her engaging posts on this vital issue.
  • Reinventing finance British Journalist Ian Fraser spoke passionately in Oct. 2009 about the need for financial reform and why it is vital that governments in the UK, US and Europe not resort to the quick fix.
  • Why we need to regulate the banks sooner, not later Financial Times blogger Kenneth Rogoff argues that bailouts aren’t enough. In the absence of more regulation and enforcement of those regulations, nothing will change. Tip to @Ian_Fraser