September 6, 2009
Booth on the Causes of the 2008 Credit Crisis
Things Happen, by Richard A. Booth, Villanova University School of Law, was recently posted on SSRN. Here is the abstract:
In this essay, I consider various theories about the cause the 2008 credit crisis and by implication what should be done to prevent future such events. These theories include the use or overuse of securitization, the misuse of commercial paper, deregulation of the banking business and the futures markets, and compensation practices that operated as an incentive for excessive risk taking. In the end, none of these factors appears to be sufficient to have caused the crisis. Moreover, none seems to merit significant reform beyond those likely to result from market forces. I also consider the possibility that over-regulation (in the form of mandated changes in accounting standards and reliance on rating agencies) was a significant aggravating factor. Given that none of these factors appears sufficient alone to have triggered the 2008 credit crisis, I consider the housing bubble itself and the monetary policy that some suggest led to it. While the data show significant increases in the flow of money into mortgages and the financial sector in general, the housing market does not appear to have been excessively leveraged in the aggregate although it has grown significantly more leveraged since 1995. Neither does it appear that monetary policy resulted in interest rates that were too low by traditional standards. Nevertheless, it does appear that the supply of capital increased despite stable interest rates – likely because of financial innovations and the inflow of foreign funds – and that traditional measures of money supply failed to detect these significant and fundamental changes in the way the financial economy works. To be sure, the 2008 credit crisis has exposed discrete problems that could be addressed by targeted regulation. Specifically, bankruptcy law could be reformed to permit the revision of mortgages on primary residences, mortgage brokers and originators could be regulated as are investment advisers or insurance agents, and credit default swaps could be traded on exchanges rather than over the counter. But these reforms are likely to evolve as a result of market forces anyway. In the end, the 2008 credit crisis appears to be yet another one-off event such as the 1987 market crash, the thrift crisis of the early 1990s, the 1998 failure of Long Term Capital Management, the dotcom bubble and bust, and the collapse of Enron and others in 2001. It is unlikely that any reform that emerges from the 2008 credit crisis will avoid future crises that are likely to come from as yet unidentified sources. But it is unlikely that the current crisis will repeat itself.
Bradley on Global Regulation of Credit Ratings
Rhetoric and the Regulation of the Global Financial Markets in a Time of Crisis: The Regulation of Credit Ratings, by Caroline M. Bradley, University of Miami - School of Law, was recently posted on SSRN. Here is the abstract:
The market for credit ratings is a transnational market dominated by a small number of credit rating agencies (CRAs). The article examines how CRAs have used market protection rhetoric and harmonization rhetoric during the crisis in the financial markets. As criticisms of pre-crisis financial regulation proliferated one might have expected CRAs to be less forceful in their resort to market protection rhetoric. CRAs’ lobbying strategies have evolved as discussions about the broader future of financial regulation have evolved, and they have conceded a greater role for regulation in 2009 than they had before the crisis, but they continue to emphasize, with some success, that as a global business they should not be subjected to different rules in different jurisdictions, and to insist that the core of their methodological approaches to rating should be unregulated.
Selling Life Settlements of Old and Sick is Wall St.'s "Next Big Thing"
The New York Times has a disturbing front-page article, New Exotic Investments Emerging on Wall St. (by Jenny Anderson), recounting the latest "exotic investment" Wall St. is planning -- securitization of "life settlements." Life settlements involve the sale of life insurance policies by the ill or elderly for cash to promoters who then bundle them and sell participations to investors. Securities professors are familiar with viatical settlements from the 1996 SEC v. Life Partners opinion, in which the D.C. Circuit bizarrely stated that these interests were not securities because the investors' reliance on the efforts of others only occurred at the pre-investment stage and thereafter profitability turned on the number of years the insured continued to live. The article quotes professionals as saying these are the "next big thing" because the risks of the investment do not correlate with market-based investments, thus allowing for diversification of risk. In the 1980s, viatical settlements proved to be poor investments because with drug therapies, the life expectancy of AIDs patients proved to be longer than "bargained for." But Wall St. says that they have become more sophisticated and that there are ratings agencies that can accurately assess the risk of these investments.
Never underestimate the unrepentent greed of Wall St.