Accountable Strategies blog

A blog about accountability issues in the public, private, and nonprofit sectors

Government’s role in the subprime mortgage crisis

Posted by David Kassel on September 20, 2007

Once again, a major financial scandal appears to stem, at least in part, from a failure of governmental oversight—-in this case, oversight that has been sloughed off onto the private sector.

The problem involves the use by government regulators of private corporations, such as Moody’s, S&P, and Fitch, to rate the securities that have been at the center of the spreading subprime mortgage crisis. 

 The New Republic reports that the government has overlooked an apparent conflict of interest on the part of these rating organizations. The conflict stems from the fact that the securities involved here are largely based on mortgages sold by lenders to investment banks.  As The New Republic noted, the private rating organizations are paid large fees by the issuers of these securities to issue their ratings.  

The predictable result has been that the rating organizations have consistently rated these mortgaged-back securities as “investment grade,” meaning they are viewed as carrying low risk.  But many of these securities were, in fact, highly risky because they were based on mortages given to borrowers who could not afford to pay them.

The New Republic notes that the regulators were “entrusting much of their own oversight responsibility to the ratings agencies.”  It was clearly a mistake on the part of the regulators, including among them the Securities and Exchange Commission, to slough off their oversight responsibility in this case because the ratings agencies were in the tank with the issuers of the securities.

While the private sector often complains about the burdensome nature of government oversight, it seems more clear than ever that oversight of the private sector is necessary to protect the rights of the public, taxpayers, and other stakeholders.  When that oversight itself is privatized, the problems can be compounded.

In a panel discussion this week at the Kennedy School of Government,  Jane Nelson, head of The Kennedy School’s Corporate Social Responsibility Initiative, noted that we are entering an age in which private enterprise is becoming more influential, while “governments are facing growing constraints” in carrying out their traditional functions.

I emailed Allen White, one of the speakers on the Kennedy School panel, to ask him whether he thought the subprime mortgage crisis can be seen as a consequence of the growing influence of the private sector, which has come about, in part, as a result of the increasing privatization of governmental functions, such as oversight.  White, a senior fellow at the Tellus Institute in Boston, is the author of a recent paper calling for the writing of a new “social contract” among government, the citizenry, and the private sector.

White responded cautiously to my question.  Privatization of governmental functions “is not intrinsically ill-conceived,” he noted.  But, he added, the use of private securities rating organizations:

…is an example of privatization of a service that is one of the pillars of efficient and fair capital markets.  As such, the terms and conditions of privatization must be set with extreme prudence to avoid the conflicts that are now the subject of Congressional investigation.

Let’s hope one outcome here is a re-assessment of the role and practices of government in this key area of operation of our capital markets.

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One Response to “Government’s role in the subprime mortgage crisis”

  1. […] Morgan Brown wrote an interesting post today onHere’s a quick excerptI emailed Allen White, one of the speakers on the Kennedy School panel, to ask him whether he thought the subprime mortgage crisis can be seen as a consequence of the growing influence of the private sector through the increasing … […]

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