...is of the ratings agencies. Seriously, if you had to pick a single group who were most directly responsible not in terms of moral culpability, but in terms of their huge intellectual mistakes being directly tied to the housing bubble...well it's gotta be the ratings agencies. I couldn't find how many total employees Moody's, Fitch, and S&P have, but I bet it's a fairly small group of people, given how much influence they had. Don't get me wrong, Greenspan had more per capita influence on the housing bubble, but you can't tell the story of what happened without invoking the absolutely horrendous job the ratings agencies did.

So what I was originally going to post is that these firms have largely emerged unscathed. After all, AIG shareholders have gotten trounced, as well as the shareholders of other firms that got in over their heads and benefited the most during the boom years. But I don't see S&P posting billion dollar losses. It's true, the agencies' profits are down, but that's because of the general downturn in the credit markets; it's not that their former customers are taking their business elsewhere.

But there's a new twist: Dan Simmons sent me this WSJ article that explains that the ratings agencies might see up to a billion-dollar windfall from the Fed's recent announcement of further experiments in hyperinflation. In any deal spurred by the Fed's program, the ratings agencies need to come in and provide the requisite labeling--for a fee. This part's great:

Now the government is in the uncomfortable position of rewarding these same firms through a new program that will result in numerous companies issuing securities. If the ratings companies are wrong this time around, the Federal Reserve and the Treasury -- and therefore taxpayers -- will be on the hook for some losses.

A Federal Reserve spokesman declined to comment. At a Senate hearing in Washington earlier this month, Fed Chairman Ben Bernanke said the central bank has looked at the models of the major rating companies and is "comfortable" they can rate securities eligible for the new program "in an appropriate way."

The reason that Moody's et al. are invulnerable to competition is--you guessed it!--government regulation. When banks, life insurance companies, and other heavily regulated financial institutions buy financial assets, they typically need a minimum rating (e.g. AA or better). (This regulation is intended to ensure that your life insurance company can pay your wife when you die.)

But then that begs the question: Who is an acceptable rater of the bonds a bank buys? The bank president can't simply call up his brother-in-law and have him send over a notarized letter declaring everything on the books is a AAA.

Although I think the rules for being an acceptable rating agency are in theory open to a wide field of competition,* in practice the regulations ensure that Moody's et al. have a cartel.

If any companies should be liquidated because of their executives' mistakes during the housing boom, it is the ratings agencies. But instead of heads rolling, they get a nice cut of every injection of new Fed money into the credit markets.


*von Pepe chides me in email and says that the government really is picking the cartel. The SEC requires the ratings for the regulated buyers to be performed by "Nationally Recognized Statistical Rating Organizations," and if you check out the definition of this phrase, it turns out that only the Big Three of Moody's, Fitch, and S&P qualified up to a few years ago, and now only 7 or so qualify. But that was my point, that if you read the actual regulation, it doesn't say, "You need to get your rating from Moody's," but in practice to comply with the regulation you have to go to the big boys.