The Pin Factory Blog

It's been a year since the meltdown of financial markets began, yet the media and politicians are still wielding pitchforks against City Bankers. In some cases this is understandable: even if their decisions were being driven by expansionary monetary policy, it is hard to deny that many bankers took extraordinary financial risks, pocketed their bonuses, and then passed the losses on to the taxpayer. That's not the way free markets should work. However, there is another set of financial institutions that seem to have evaded the limelight for now – the Credit Rating Agencies (CRAs).

These companies – such as Moody's, Standard & Poor and Fitch Ratings – were charged with assessing and attributing risk to financial derivatives created by banks. These ratings, ranging from AAA through to C, would then determine the risk involved with those securities and hence the price and demand for them. This seems a pretty trivial task for companies with vast resources and expertise until you realize that these companies gave securitized debt, containing toxic sub-prime loans, a AAA rating.

Naturally with such a seductive low-risk rating these securities were bought up by banks and in the end it was these, which caused the stagnation of inter bank lending. This kind of asymmetric information in the derivatives market added to the crisis. Yet little has been done to reform CRAs. President Obama has proposed 'reforms' which would basically be a slap on the wrist, but there has been no full-scale investigation as to why these debts were given such high ratings (apart from the companies blaming faulty models). The first major move was from a US pension fund which is attempting to sue three of these agencies for $1 billion.

More should be done. Evidence in the IEA's Verdict on the Crash: Causes and Policy implications points towards a systemic failure in CRA strategy, with too much emphasis placed on mathematical modeling, rather than economic reasoning. Interestingly, the solution may be the reverse of current government proposals: a reduction in regulation. Reducing regulation would increase competition in the credit ratings market (where market entry by new firms is currently nigh-on-impossible), increasing the number of different 'opinions' available and bringing an end to the all-too-cozy oligopoly of present-day CRAs.

Peter Mandelson was thinking along the right lines when he proposed partial privatisation of Royal Mail (although I would have gone for the full deal). In the end, however, pressure from the Communication Workers Union as well as backbench Labour MP’s sank the proposals. That surrender was a bad move for a government supposedly keen to fix this loss-making institution.

The Royal Mail's pension fund deficit is now running in the billions of pounds (which will be paid for by the taxpayer to the tune of around £12bn) and inefficient practices still prevalent. Even turnaround experts like Allan Leighton, who has helped some of the biggest names in business, have been unable to make a significant difference hitherto.

The Royal Mail has been performing even more abysmally with the gradual opening of the postal market to private enterprise, but the CWU still fails to see the benefits privatisation could bring. Even partial privatisation would mean a more efficiently run Royal Mail, leading way to modernisation in the company’s operations and structure as well as helping to reduce the pension fund deficit (for which the unions are demanding a government bailout).

Striking from union workers has meant a slow down of operations, damaging not only Royal Mail's services, but also its reputation. But the unions are being unrealistic: without the modernisation that privatisation would bring the Royal Mail does not stand a chance against efficiently run, well-managed private sector competitors, in an increasingly open market. Ultimately, the Royal Mail must adapt or die.

As a keen economist (free market economist of course!) I consider it a great privilege to have the opportunity to work at the Adam Smith Institute. I look forward to this week at the ASI and hope to learn a lot about economics and politics. Besides Economics I recently sat AS exams in Politics, Maths and Physics. My main interests lie in political economy and I hope to apply to read Philosophy, Politics and Economics at Oxford University. To me these are the subjects that really govern our lives, day in and day out, and only by studying them can we truly understand not only the workings of a society but also of human nature itself.
 
There has been a lot of cynicism and criticism surrounding the capitalistic system which I myself hold dear, but the thing these critics fail to realise is that long-term prosperity sometimes requires short-term losses. All Gordon Brown’s ‘cushioning’ of the economic cycle during the Blair years did was to prevent those losses from happening naturally, so that they gradually built up into much larger problems – as is evident in today’s political economy. So let's not look at this crisis as a systemic failure of the free market but of an economic trough, which has been magnified by poor governance.