Pretty much everyone agrees that we have a ratings agency problem. But I think the conventional way of describing it as a “conflict of interest” that’s created by the fact that “banks pay them to rate their securities” leaves some crucial steps out.

Like suppose I was opening a salad joint in downtown Washington and wanted to convince people of the high quality of my salads. This might be tricky, especially if my business model was to buy a bunch of crappy ingredients and tell people they’d been mixed together in just such a way as to be delicious. One thing I definitely couldn’t do is just turn to Moody’s Salad Rating Agency and pay them to say “these ingredients may be gross individually, but combined they’re delicious—AAA!.” And the crux of the problem isn’t that regulators would stop me, it’s that it would be pointless—nobody would take Moody’s Salad Rating Agency seriously if it operated on that business model.

A plan that actually might work is that I could go to The Washington Post and promise to pay them under the table in exchange for a favorable review. But it’s important to note that that kind of fraud isn’t what’s going on with the ratings agencies. Everyone understands that this conflict of interest exists, but it doesn’t kill them off.

That seems mysterious, and at first glance you might reach for a free market approach. After all, why does it make sense for me to pay Moody’s SRA in the first place? Well, presumably because salad-eaters deem Moody’s to be credible. Consequently, even though Moody’s does< want as much business as possible, Moody's knows that in the long run it maximizes revenue by only giving the AAA-rating to really good salads. If Moody’s engaged in some giant salad screw-up, salad-eaters would lose faith in Moody’s-rated salad shops and reputable salad vendors would start shifting their business to other salad raters. In theory, a salad-rater could be perfectly credible notwithstanding the conflict of interest. In practice, however, consumers are likely to put more faith in third-party reviews in reputable media outlets or just rely on recommendations from friends.

The real question about the ratings agencies is why this kind of process doesn’t work. To understand the answer, you need to learn the term “Nationally Recognized Statistical Rating Organizations”. What’s an NRSRO? In short, it’s a ratings agency. But NRSRO isn’t just the name of a line of work, it’s the name of a special regulatory status. To be an NRSRO you need to be certified as one by the Securities and Exchange Commission. And becoming an NRSRO isn’t just a matter of having a fancy label, it’s embedded in a web of other regulations. For example, regulatory assessment of bank and insurance company capital reserves requires assets posted as reserves to have an NRSRO-certified rating. NRSRO-certified ratings are also relevant to regulations about money market funds and some pension funds.

This does two things. One is that it reduces competition, since it’s hard to get that NRSRO label. But that’s probably the less-important consequence. The more important consequence is that it undermines buyer-side incentives for ratings to be accurate. The “major” ratings agencies all use the widely criticized issuer-pays model. But if, qua buyer, you don’t like that model you can instead choose to rely on a smaller rater like Egan-Jones that doesn’t use that method. That, however, assumes you actually care about how risky the assets you’re buying are. But in many cases you care less about actual risk than about how your risk plays for regulatory purposes. It’s as if you’re not actually planning to eat the salad, you just need to tell someone else that you bought a AAA-certified tasty salad. And if you care more about the rating than the actual quality, then you don’t care whether or not Moody’s SRA has a sound methodology, you just care that it’s cheaper and more convenient to let the salad vendor go through the hassle of getting the rating.

Note that this is an issue where adopting the kind of discretion-free “Roman” approach that many liberals have been promoting in other contexts is part of the problem. The rigid rule may have made sense when it was initially adopted, but over time what started as a rule business practices have evolved that are based on knowledge of how the rule works that undermine its spirit.

This is a blog about politics, and politics on some level is about legislative proposals and whether they can pass and whether they help or hurt efforts to win elections and whether election outcomes help or hurt prospects for specific pieces of legislation. But on another level, politics is about ideas and sentiments and attachments and worldviews and so forth.

And to me, at least, when the topic comes to immigration I’m much more interested in that more abstract level of conversation than in narrow debates about forging a legislative compromise. The bottom line, for me, is that this is an issue fraught with misunderstandings. People wildly underestimate the extent to which immigration is a positive-sum interaction that leaves almost everyone better off. It’s true that as is typical in life some individual people are harmed by high levels of immigration, but those people are a distinct minority. It makes dramatically more sense to try to improve the living standards of native-born Americans through higher taxes to finance more and better public services than it does to try to improve the living standards of native-born Americans through trying to prevent people from moving to the United States to do work in exchange for money.

Accurately keeping track of which people are entering the country has some real value from a counterterrorism and smuggling point of view, but limiting non-criminals’ ability to come here as tourists or workers is a low- to negative-value proposition.

What’s more, though it’s inevitable that democratic politics will focus mostly on what Americans want and need from an individual perspective it makes more sense to take a more global outlook. Relative little of the most intense suffering in the world takes place in the United States or other developed countries. And one of the very most useful things developed countries can do to alleviate intense suffering is to allow people to come live in our countries and do work in exchange for money. Developed countries are nice places with democratic politics and liberal rights and economic opportunity. It’s good for people to experience these things and it’s good to expand the number of people who have the opportunity to experience them. The right to move where you want is one of the most important rights a person can be granted, and it’s a shame that so few people have that right.

Obviously, that’s all way off message and not where politics is going. But we’ll be talking about migration in 2020 and 2030 and 2040 and 2050 and beyond and it’s important to not just promote good bills, but sound, humane ways of thinking about the issue.

The executive director of the Major League Baseball Player’s Association has released a strong statement condemning the Arizona immigration law. I’ve pasted it below the fold:

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