BlackRock's Potential Conflict of Interest

This is a somewhat alarming report.
From the WSJ:

BlackRock Inc., which scored multiple government assignments during the financial crisis, is a contender for another prestigious gig: helping state regulators size up risks in insurers' investments.
The money manager and risk-advisory outfit is among a handful of firms that have talked with officials from the National Association of Insurance Commissioners lately about possibly taking on a slice of work now done by the major ratings firms, according to regulators and an official at the NAIC.

Why is this alarming? From POGO:

Another company that is reportedly under consideration for the contract is PIMCO...
To understand why hiring a company like BlackRock or PIMCO could raise the risk for conflicts of interest, just take a look at BlackRock’s latest quarterly SEC filing. As of June 30, 2009, BlackRock is managing a whopping $1.37 trillion in assets, including $510 billion in bonds, $317 billion in cash products, $330 billion in stock funds, and $52 billion in alternative investments such as hedge funds. The company also advises clients on $166 billion in assets, including many of the same types of assets that it would be evaluating for the NAIC. And these numbers will soon be increasing thanks to BlackRock’s recent acquisition of Barclays’ investment unit, which, according to Bloomberg, will create a “company overseeing $2.7 trillion in assets—more than the Federal Reserve.”

To be fair, BlackRock told the WSJ that the company has “very strict policies and procedures in place to protect confidential client information and manage any potential conflicts of interest.” However, there's still potential for abuse if they get such a contract.

It's important to note that this is a severe strike against traditional ratings agencies, who have been increasingly viewed as major culprits in the recent crisis. However, I don't think the solution is to simply ignore them. Consider the fact, instead, that ratings agencies are for-profit institutions, which in and of itself raises conflicts of interest. A hypothetical: suppose JPMorgan goes to Moody's to ask for a rating on some assets they want to securitize. Moody's comes back with a bunch of poor grades. Well, Standard & Poor's could easily jump in with its own 'research', claiming they are able to rate the assets at a higher level which would allow JPM to create a more stable security, though in reality the assets are now of unclear strength. S&P, looking for customers, has every incentive to do something like this when regulatory enforcement is weak. That link has an SEC report about how much conflict of interest exists for ratings agencies, and how the SEC did absolutely nothing about it. All bark, no bite.
One possible solution (and I'm just throwing something out there) is for all ratings agencies (at least, all of the Big 3, or perhaps some combination of the Big 3 and other smaller firms) to be required to independently rate assets when any one of them is asked, and investors be required to use the 'average' of the three ratings. The problem there is increased cost to investors, but perhaps that would give investors incentive to do a little research of their own and not waste time on potentially risky assets. Does this make any sense?

Update: Good read from Fortune on the current state of affairs with ratings agencies.

Criticism and Solutions

I've read a lot of articles about the crisis over the past year. Lots and lots of articles. I've started to notice that the vast majority of them (including my own, to be fair) tend to be focused on criticizing mistakes. What bothers me is that articles providing solutions, not just criticism, are few and far between. I'm going to try to focus future posts, both links to articles along with my own thoughts, on solutions. Criticism leads to pointless debate; proposals lead to useful debate. Granted, the tiny debates that occur here are hardly meaningful, but I'm doing my best!

Anyway, sorry for the rant. On to some good reading:

• An article from the Economist, pointing out that the failure of regulators in this past crisis may have been due to a lack of incentive to regulate. Interesting, though not particularly novel, insight. Thankfully, in line with my earlier diatribe, there is a proposed solution in the article (though I think it's a weak solution, in that there's not much substance offered):
  

  Incentives also help explain why regulators resist the delegation of powers to supranational institutions. Supervisors may wish to protect the local industry or secure a competitive edge over other financial centres. Even without a protectionist agenda, supervisors are prone to capture: because they talk to local institutions on a daily basis, they are likely to empathise with the competitive pressures that those banks face. Pay is also a problem. In most countries compensation structures for national supervisors will involve low salaries, no bonuses and small rewards for doing a good job. Supervisors get into trouble if they go out on a limb and make a technical mistake (and a bank sues), but face fewer problems if everybody makes the same material mistake and the system goes down. It does not help that officials are repeatedly told that the smartest people go where the money is—into the banks, in other words, not the agencies that regulate them. ... The solution to the problem of local regulatory capture would be to rely more on supranational authorities. ...And beyond Europe, too, policymakers ought to match their new-found focus on incentives in the private sector with more attention to their own.

• Geithner has been known to be very close with top banks on Wall St. This AP article shows just how close using phone records obtained via FOIA:
  

  After one hectic week in May in which the U.S. faced the looming bankruptcy of General Motors and the prospect that the government would take over the automaker, Geithner wrapped up his night with a series of phone calls. First he called Lloyd Blankfein, the chairman and CEO at Goldman. Then he called Jamie Dimon, the boss at JPMorgan. Obama called next, and as soon as they hung up, Geithner was back on the phone with Dimon.
  While all this was going on, Geithner got a call from Rep. Xavier Becerra, a California Democrat who serves on committees that help set tax and budget policies.
  Becerra left a message.
  In the first seven months of Geithner's tenure, his calendars reflect at least 80 contacts with Blankfein, Dimon, Citigroup Chairman Richard Parsons or Citigroup CEO Vikram Pandit. Geithner had more contacts with Citigroup than he did with Rep. Barney Frank, the lawmaker leading the effort to approve Geithner's overhaul of the financial system. Geithner's contacts with Blankfein alone outnumber his contacts with Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee.
  

  This is pretty disturbing stuff. The Baseline Scenario points out that it wasn't even that he was calling the biggest or most troubled banks. He was calling his friends. Although that's fine when one is in the private sector, I think it's quite wrong for a public servant. Then again, who really thinks of Geithner as a public servant after how he bailed out the banks?
  
• The NYT talks about how the debt-securitization market is still pretty frozen:
  

  Many investors have lost trust in securitization after losing huge sums on packages of subprime mortgages that had high default rates. The government has since spent more than $1 trillion trying to restore the markets, with mixed success.
  Until more of the securitization market revives, or some new form of financing takes its place, a wide range of loans needed to secure a lasting economic recovery will remain elusive, experts said.
  

  The question here is, why should we want to return to securitization? Naked Capitalism and Krugman both comment on this. I like that Krugman offers a solution, though an oft-repeated one.
  NC:
  

  What is intriguing about these comments is the tacit assumption that we have to go back to status quo ante, of having a significant amount of loans on-sold into credit markets rather than retained on bank balance sheets. Yet we have seen the superficial appeal of that system comes at considerable cost. Securitization allows for more “efficient” banking, in the sense that banks can operate with far less equity than if they conducted banking the old-fashioned way, by holding the loans they originate.
  But this prized efficiency comes at high social cost. First, the idea that these loans were really off balance sheet in many cases was spurious. For some types of conduits, like credit card trusts and SIVs, banks did intervene when the supposed off balance sheet vehicles got in trouble. Indeed, credit card receivables could not have been off-loaded absent parent support. So the supposed efficiency gain was phony; the banks were simply using off balance sheet vehicles as a way to run with less equity than they actually should have had, but the regulators accepted the charade and looked the other way.
  Second, as we know, securitization reduces the incentives to do proper borrower assessment and even worse, means no one is monitoring the borrower on an ongoing basis.
  

  Krugman:
  

  But here’s my question: why does it have to be a return to shadow banking? The banks don’t need to sell securitized debt to make loans — they could start lending out of all those excess reserves they currently hold. Or to put it differently, by the numbers there’s no obvious reason we shouldn’t be seeking a return to traditional banking, with banks making and holding loans, as the way to restart credit markets.