Those darn unintended consequences

Dollar BillsYesterday’s post touches on the enormous direct costs attributable to the federal government’s questionable policy of regulating business through criminalization of bad or simply incorrect business judgments.

However, as enormous as those direct costs are, the indirect costs of criminalizing bad business judgments dwarfs the direct ones.

Whether management makes such judgments correctly is a fundamental risk of business ownership. Criminalizing that risk — through the prism of hindsight bias — will simply make executives in the future less likely to take the risks necessary to build wealth and create jobs while not deterring in the slightest the Bernie Madoffs of the world from embezzling money.

Business owners deserve protection from theft, but not from risk taking, and it’s not clear that government prosecutors know — or even care about — the difference.

Those indirect costs came to mind again as I read this Wall Street Journal article (H/T Russ Roberts) on the unintended consequences arising from the government?s new regulations concerning rating agencies:

Ford Motor Co.’s financing arm pulled plans to issue new debt, the first casualty of a bond market thrown into turmoil by the financial overhaul signed into law Wednesday.

Market participants said the auto maker pulled a recent deal, backed by packages of auto loans, because it was unable to use credit ratings in its offering documents, a legal requirement for such sales. The company declined to comment.

The nation’s dominant ratings firms have in recent days refused to allow their ratings to be used in bond registration statements. The firms, including Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, fear they will be exposed to new liability created by the Dodd-Frank law.

The law says that the ratings firms can be held legally liable for the quality of their ratings. In response, the firms yanked their consent to use the ratings, hoping for a reprieve from the Securities and Exchange Commission or Congress. The trouble is that asset-backed bonds are required by law to include ratings in official documents.

The result has been a shutdown of the market for asset-backed securities, a $1.4 trillion market that only recently clawed its way back to health after being nearly shuttered by the financial crisis.

Professor Roberts sums it up in his post by quoting Hayek:

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

1 thought on “Those darn unintended consequences

  1. The entire notion of rating agencies is flawed. And their inability to protect us from the real estate meltdown is Exhibit A in the case against them.
    Fundamentally, it’s based on the notion that people can’t think for themselves and need to be protected by politicians. And in fact, the very problem they try to remedy they cause. Eventually people believe what you tell them and stop thinking. Thus, the real estate meltdown where everyone trusted the rating agencies despite mountains of evidence to the contrary.

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