Numbers Game

In re my post on the end of the CBO process, Kevin Drum asks "What's wrong with hitting budget targets?" 

Well, to start with, a bunch of the mechanisms used to hit those targets were pretty sketchy--as Kevin himself noted a few days ago, the revenue raising starts now, but the spending starts in 2014; this has the effect of both increasing the deficit reduction, and shrinking the price tag of the bill.  If liberals can't pass a $2 trillion ten-year bill with voters, then they shouldn't shift the time window so they can artificially call it a $1 trillion bill.  The Bush sunsets may have been a gimmick, but at least the sunset will actually occur.  Their estimates of the cost of the Iraq war may have been wrong, but at least they were genuinely, idiotically wrong, not the artifact of a budget metric.

But to answer the more general question, I will . . . pose another question:  what was wrong with the ratings on mortgaged-backed securities?

One of the reasons that we got so deep into the crisis is that people were substituting ratings for common sense.  Not all people, but enough.  If a security was rated AAA, well then, it must be an excellent security.  People confused the rating with an actual prediction of the future.

Indeed, the rating was supposed to bear some (not perfect) resemblance to the future.  But the more important the rating got, the more money there was to be made by gaming it.

The raters used metrics--perhaps more than they should have.  So if you knew the metrics, you could tweak the security to get a good rating on your toxic waste.  In the past, a well designed security would (arguably) have naturally passed the metrics.  But now the point was not to build a well-designed security; it was to design a security that would just barely pass the standards used by Moody's or S&P.  Then people would buy your crap, and . . .  oops! we crashed the financial system.

This also appears to have been the genesis of substantial fraud in the mortgage market.  Computers had arbitrary cutoffs, so many future metric-gamers got their start tweaking inputs by small amounts to see if they could hit the numbers--raising the annual salary by $500, or the FICO score by a couple of points.  Individually, this actually makes reasonable sense--if you make $75,000 a year, $40 a month is probably not going to break your budget.  Collectively, and taken further, they were disastrous.

People are treating the CBO estimates as if they are predictions.  They aren't.  The CBO does not make accurate predictions of the future, because it can't.  Moreover, the CBO very explicitly does not forecast the most likely scenario; it forecasts what is written into current law, no matter how unlikely it is that this current law will be implemented.  Thus the ritual annual "temporary" fixes in things like the AMT and the SGR, performed to keep the full cost of the measure from showing up anywhere, even though we know we are never going to let them go into effect.  The CBO's goal is not accuracy, but consistency:  a method that is not influenced by political predictions, and generates similar results for similar bills. 

Accurate predictions would require estimating, for example, whether the Medicare cuts will prove unworkable for either political or practical reasons, and be repealed.  But that is not the CBO's job.  And it shouldn't be; the agency could not function if it were injected into politics.

Presented by

Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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