Nouriel Roubini

There’s good reason why Nouriel Roubini has been dubbed Dr. Doom. After reading his book co-authored with Stephen Mihm, Crisis Economics, I despair for our economic system.

Not that it screams gloom and doom on every page – it doesn’t. The book is a pragmatic, even occasionally routine and boring analysis of financial crises, particularly the recent one, and what to do about them.

The details as explained by Roubini and Mihm, however, make the recent crisis seem inevitable, hard to stop, and very hard to keep from happening again.

Ratings agencies

Here is just one example. The ratings agencies, chiefly Moody’s, Standard & Poors, and Fitch, originally charged bond investors for ratings. But bond investors could avoid paying by cadging ratings from other bond investors. So the ratings agencies started charging bond issuers instead.

That brought about major conflict of interest problems. Roubini and Mihm offer the analogy of a professor who charges students to take his course and receive a grade. If other professors offer the same course, students will flock to the professor who gives the highest grades. Those who give lower grades will have no students and earn no money. Hence, grade inflation is inevitable.

Similarly, if a rating agency doesn’t offer high ratings, it will lose business to those who do.

Presto, you get ratings agencies competing with each other to give high ratings, and even advising their clients – bond issuers – (for a fat fee, of course) on how to obtain high ratings.

Roubini and Mihm discuss various remedies for this situation – virtually all requiring government intervention – but somehow I don’t believe they’ll work. The authors admit that some of them won’t work – for example, going back to the original model in which investors pay the ratings agencies. Others feel like trying to nail jelly to a wall. We know now how great is the ability of the financial industry to do end-runs around regulation.