February 26, 2009

Slippery slopes and boiling frogs

Casey Martin, who was born with a terrible birth defect that crippled one of his legs, leaving him in recurrent pain, starred on Stanford's famous 1995 college golf team along with the full-blooded Navajo Notah Begay, who went on to win four times on the PGA tour before alcohol brought him down, and with Eldrick Woods Jr., who, last time I heard, remains employed in a golfing capacity.

Despite his disability, Martin enjoyed enough success on the minor league Nike tour to qualify for the PGA tour in 2000. His lawsuit under the Americans with Disability Act to be allowed to use a golf cart on the PGA tour went all the way to the Supreme Court, where he won in 2001.

Martin's was not a popular victory with players, with both Jack Nicklaus and Arnold Palmer protesting that it would open the door to other players getting a note from their doctor to be chauffeured about the course.

It was easy to imagine a player with a bad back like Fred Couples trying to get permission for a cart, and then the whole thing descending into carts everywhere.

And yet, eight years later, the PGA Tour hasn't slid down the slippery slope. So far, as far as I can tell, a cart has only been used once by somebody other than the severely unlucky Martin: Erik Compton rode in one tournament last fall because he had gotten his second heart transplant only a few months before.

Essentially, golf has a fairly healthy culture of sportsmanship where top players don't want to be seen as abusing loopholes. So, it hasn't been hard so far to restrict cart-riding to rare human-interest stories like Martin and Compton.

In the early 1970s, the Wall Street credit-rating companies (S&P, Moody's, Fitch) switched over from charging bond-buyers for rating to charging bond-issuers. In the mid-1970s, the government started writing regulations requiring certain levels of ratings from the big three ratings firms: in effective, establishing a legal cartel.

Anybody with a suspicious mind can guess what happened next: right down the slippery slope. The ratings firms succumbed to this conflict of interest and exploited their protected position to get rich by rating crud as gold.

Except, that didn't happen right away. The slope wasn't all that slippery. Apparently, the culture was sound enough that it took a couple of decades for the ratings firms to fall prey to the incentives.

Unfortunately, by then, everybody had forgotten that the credit ratings firms have a huge conflict off interest. They'd had that obvious conflict of interest for so long that people had stopped worrying about it. When I Google for it, I can't find an article talking about their "conflict of interest" before May 2007. A 2006 reference book entitled the Euromoney Encyclopedia of Debt Finance blandly asserts:
Although there would appear to be a conflict of interest as a result of providing a supposedly independent rating in exchange for a fee, this risk is fully mitigated by the market discipline imposed by the need for investor acceptance of the ratings.

Or, perhaps more accurately, the conflict of interest won't be a problem until it starts being a problem.

My published articles are archived at iSteve.com -- Steve Sailer

20 comments:

Karl said...

"Essentially, golf has a fairly healthy culture of sportsmanship where top players don't want to be seen as abusing loopholes."

Then why the arms race with the high-tech clubs? Why not a set of standardized clubs for everyone?

Ivy said...

I agree with what you're saying. But it seems at odds with some of your conservative peers.

Many secular-based (not necessarily atheistic, but not deriving principles from religious doctrine) conservatives oppose gay marriage primarily due to a "slippery slope" argument. The notion that if gay marriage is accepted, other improper forms of marriage will be codified such as polygamy, beastility, pedophilia,etc.

It seems you're disowning the idea of the actuality of a "slippery slope" (and I agree), but again, it seems to oppose your peers.

Anonymous said...

Great reporting. I have been wondering myself why these mortgage-backed securities were given triple A ratings.

Might it also be possible that there was a race-baiting angle? If you don't sell these people mortgages you are racist. If you rate them as junk, ipso facto, you are racist also and will be outed by ACORN, et. al.?

The even more sinister and really depressing idea is that its worse than about race, but a harbinger of permanent (at least for the next 20 years) economic decline. Minorities were simply the canaries, the most fragile group to feel the effects of 2 billion chinese and Indians happy to work for 50 cents an hour, six days a week, no social security, no health care, no workers comp., etc.

If you are a politician you can't say this and expect to get elected. So, someone, somewhere came up with this idea to create bubble wealth and maintain the illusion. A professional politician would think this way. Or was it group-think at Harvard?

If this is the case, we are in for a long, ugly fall. What are these securities worth? What are these properties worth and what will it cost to stop a general depression or very high inflation in order to pay.

Pat Shuff said...

Egan-Jones, based in Philadelphia, does not accept any compensation from the issuers whose paper it rates; the
only revenue it receives is from the subscribers to its service, mostly buy-side firms.

Like other credit-rating firms, Egan-Jones basically assigns shorthand grades on the likelihood that a bond
will default and leave investors in the lurch. But Mr. Egan has only 15 analysts in his company, compared
with about 1,000 apiece at S&P and Moody's.

Mr. Egan says he relies on the analysts but doesn't disclose their names, partly because of security
concerns. He says he has been threatened with lawsuits and bodily harm by people who disagreed with his
research conclusions. "We're big boys, but I have to do what I can to minimize it," he says.

Over the years, Mr. Egan's targets have included auto makers and highfliers such as WorldCom Inc. and
Enron Corp., which he downgraded before larger rating firms lowered their ratings and the companies
collapsed.

Lately, though, he has been drawing attention for his negative views on bond insurers such
as MBIA Inc., which he rates at B -- 14 notches below its triple-A financial-strength ratings from S&P
and Moody's.

Sure, one necessary step in creating a really big investment
fraud is hitching your company’s wagon to Wall Street’s
perpetual financing machine.
Yes. Fannie Mae (FNM) and Freddie Mac (FRE) are beautiful at
that, by the way.
Aren’t they?
Oh, they’re the best at that. We don’t rate them anywhere near
AAA.

~~~~~~~~~~~~~~~~~~~~~~~

Plucked from a mixture of articles '06-08.

http://tinyurl.com/b88fd5

~~~~~~~~~~~~~~~~~~~~~~~~~~

To most publishers, it would've been a touch of golden luck: a manuscript about the worst economic crisis in decades, written by a financial insider and finished months before rivals had even a rough draft ready. Instead, Wall Street investor Barry Ritholtz's "Bailout Nation: How Easy Money Corrupted Wall Street and Shook the World Economy" appears to have become a parable for the same corporate shenanigans that it catalogs. In early 2008, McGraw-Hill paid a five-figure advance to Ritholtz, a frequent CNBC guest and author of "The Big Picture," a popular finance blog. When Congress passed its $700 billion bailout bill, McGraw-Hill's contract with Ritholtz looked prescient. The imprint started taking pre-orders and set a March release date. Then, in early February, it dropped the book.

Ritholz claims that he and McGraw-Hill butted heads over scathing passages about bond-rating agencies, which accepted large fees from investment banks while giving sterling ratings to subprime mortgages, helping the banks sell them at premium prices. In his original draft, Ritholtz dubbed this "payola" and called the rating agencies "pimps." His wrath extended to Standard & Poor's, a rating agency owned by the same company as McGraw-Hill. According to the author, when his editors took issue with his tone, he agreed to water it down but insisted on criticizing the agencies. Soon after, the book was dropped.

But Ritholtz isn't too upset: he says rivals are offering better advances than the one he's returning to McGraw-Hill.

http://www.newsweek.com/id/185848

Anonymous said...

Proof that golf just isn't a sport:

"Erik Compton rode in one tournament last fall because he had gotten his second heart transplant only a few months before."

dearieme said...

"Except, that didn't happen right away. ...Apparently, the culture was sound enough that it took a couple of decades for the ratings firms to fall prey to the incentives." This accords with my observation that conservatives are very shrewd at seeing the direction of social change but prone to overestimating its speed. That's because they overlook how conservative people can be, which is pleasingly paradoxical.

Anonymous said...

I believe the SEC helped put the grease on the slippery slope by specifically designating certain rating agencies as the go-to guys, ipso facto, reliable. Thus, as with CRA, the government puts its mitts on the market and it invites corruption.

jimbo said...

Call it the "Wile E. Coyote" effect: people and institutions can go quite a long time without falling after they walk off the incentive cliff. It's only when they look down that they start to fall...

Anonymous said...

Unskilled wage versus Inflation

1940 to 1970
$276.84 using the Consumer Price Index
$557.38 using the unskilled wage

1970 to 2000
$443.36 using the Consumer Price Index
$450.08 using the unskilled wage

[data calculated at: http://www.measuringworth.com/uscompare/]

Comparing the CPI and the unskilled wage from 1940 to 1970 (low immigration period) we see that unskilled wages were running well ahead of inflation. In other words unskilled workers were making real improvements in living standards.

The period from 1970 to 2000 (high immigration period) shows that unskilled workers were barely able to keep pace with inflation. That is, they were unable to make real improvements in living standards.

Obviously other factors affected this, notably the increasing returns to human capital (smarts) during this period. However, it is remarkable that there is such coincidence in the crossover from what many consider our golden period (1940 to 1970) to our stagnant period (1970 to current).

Is immigration a full explanation? Probably not, but it is a shame that we never see it mentioned during the great "inequality" debates.

Caledonian said...

Slippery slopes tend not to become a problem until people stop worrying about them.

Perhaps we would have had a reduced chance of making it through the Cold War if we hadn't bombarded ourselves with warnings about nuclear war...

Eric Rasmusen said...

Jonathan Macey's 2008 book Corporate Governance is very good, and has some pages on credit rating agencies. Of course, it probably wasn't written till 2007 either.

The rating agencies are where much of the blame for this mess is to be found. And, of course, the Main Street suckers who relied on the ratings.

Anonymous said...

Unskilled wage versus Inflation ....

Oops! That reply should have been posted in Obama's budget will solve problem of rich getting richer.

testing99 said...

Steve --

You over-rely on Google. I can tell you from personal experience that in 1995, during my MBA studies, the conflict of interest was raised repeatedly in various classes, with textbooks and scholarly articles covering that agency problem. I.E. the bond-issuer's ratings being paid for and thus probably not worth much.

I recall an article in Business Week in 1994 on that subject as well.

That is the problem with Google, a lot of stuff never made it to the web, and was not indexed, until the late 1990's. It gives you a false picture.

Heck I knew a classmate who worked for Moodys and griped about the very same thing. This was no secret.

EVERYONE knew it. They just pretended not to.

Darwin's Sh*tlist said...

The analogy I like more than the slippery slope or boiling frog is a metal bar - it's hard to bend it the first time, but each time afterwards gets a little easier, until the thing finally breaks.

It's been less than eighty years - about one healthy American lifetime - since the government began allowing voters to spend their children's money in significant amounts. Since then, both gradually and due to different fiscal "emergencies," not only are we insolvent, but people who argue for fiscal restraint are regarded as kooks.

Anonymous said...

The analogy I like more than the slippery slope or boiling frog is a metal bar - it's hard to bend it the first time, but each time afterwards gets a little easier, until the thing finally breaks.

Another analogy: a rubber band that we keep stretching a little more...then a little more...then a little more...then a LITTLE more....!

silver said...

You over-rely on Google. I can tell you from personal experience that in 1995, during my MBA studies, the conflict of interest was raised repeatedly in various classes, with textbooks and scholarly articles covering that agency problem. I.E. the bond-issuer's ratings being paid for and thus probably not worth much.

Steve's alleged over-reliance on Google is irrelevant to your redundant point -- Steve already stated that it took a "couple of decades" to become a problem (70s to '95 = "couple of decades," Testy).

That is the problem with Google, a lot of stuff never made it to the web, and was not indexed, until the late 1990's.

A point that Steve himself made a couple of weeks ago.

none of the above said...

Another place to look for the incentive-based slippery slope is in the doctor-patient relationship, which has been horribly distorted by the incentives offered by medicare and insurance companies. (Procedures pay, thinking or answering questions does not; documentation trumps everything else in getting paid; some doctors have direct financial incentives to minimize expensive care, others have direct financial incentives to funnel you off to have an MRI or something done.) Those incentives have been resisted, to some extent, because of the existing culture of doctors. But over time, that culture is changing, and will continue to change. Eventually, we're likely to get the full consequences of these conflicts of interest for doctors.

This broader phenomenon is probably important in a lot of big policy mistakes--we screw up the incentives in some field, but the existing culture and practices and such in that field prevent those screwy incentives from leading to disaster right away. Instead, the response to incentives still happens, but more gradually. And that means it's much harder for policymakers and voters to connect the cause and the effect, which means we are often trying to fix the bad policy of ten years ago with a new bad policy, whose effects we won't know for another ten years.

Anonymous said...

"...conservatives oppose gay marriage primarily due to a "slippery slope" argument. The notion that if gay marriage is accepted, other improper forms of marriage will be codified such as polygamy, beastility, pedophilia,etc.

It seems you're disowning the idea of the actuality of a "slippery slope" (and I agree), but again, it seems to oppose your peers."

The difference is that legal precedent is a codification of the slippery slope.

In the gay marriage example, the isteve argument against, that men will shy away from marriage if it's seen as gay, will, by this reasoning take a generation or so to take hold.

The other arguments against, polygamy, etc., will take less time since some judge somewhere will decide that one requires the other.

-Steve Johnson

Lucius Vorenus said...

testing99: ...I can tell you from personal experience that in 1995, during my MBA studies...

Good grief, T99 - no wonder you're so cynical about women [I would have never guessed that you were an MBA].

You need to get out and meet some chicks who aren't hyper-materialistic career-obsessed nihilists.

You might start by finding a big [healthy, growing] evangelical church within driving distance, and then attending services & activities on a regular basis.

Truth said...

"You might start by finding a big [healthy, growing] evangelical church within driving distance, and then attending services & activities on a regular basis."

Or you and Svigor could take him out to the woods in Michigan somewhere, paint your faces and your bodies like Norsemen and pound drums and do some Iron John shit followed by some manly crying and affectionate brotherhood together, I hear that relieves a lot of cynicism.