Talk has turned to the ratings agencies. The problem of these agencies has produced consternation across the ideological spectrum. They're the kind of private institution that anarcho-capitalists count on to substitute for government regulation in their ideal world. But just as governments often exhibit the same pathologies we demand they cure in private markets, in this crisis, private institutions seem to have demonstrated a classic public choice problem: the benefits of sound ratings are distributed, but while the costs are concentrated. It's thus easier for banks to undermine the ratings than for all those zillions of people who benefit from good ratings to organize to push the system back towards balance.

One could also argue that, to the extent that fraudulent lending was a problem, this was the source of it. In theory, borrowers have just as much incentive to get the mortgage broker on their side as the lenders do--there's a fixed sum of money passing back and forth. But the lenders make a lot of loans, and the borrowers only take one, which makes it easy for the lenders to develop a system which encourages brokers to screw their clients.

I don't know how much this actually happened, because there is no--I repeat, no--good data yet on mortgage broker fraud, and it's very possible that this wasn't a significant problem (no matter what you've read in the New York Times). There are countervailing forces that mitigate against it--competition between brokers, and the fact that each loan is a life-or-death matter to borrowers in a way that it simply isn't to a bank. But if it was a problem, this is probably why.

I don't know what to do about this. The normal answer is regulation, but the ratings agencies get watched pretty closely by the SEC, which is why the whole thing makes liberals queasy. Also, the regulations on them were just tightened in 2006, which isn't helpful when you are looking to do something!