Don't Underestimate the Effects of Conflicts of Interest
Back in January, I wrote <a href="http://www.cityethics.org/node/361" target="”_blank”">a
blog entry</a> focusing on the lack of transparency in the credit
rating business so central to the subprime mortgage mess that has
brought the world economy to its knees. Transparency, it has become
clear, is all important.<br>
<br>
The same goes for conflicts of interest. The <a href="http://www.nytimes.com/2008/10/23/business/economy/23rating.html" target="”_blank”">New
York Times' article</a> on credit rating executives' testimony this
week before the House Committee on Oversight and Government Reform
begins:<br>
<br>
<div>Conflicts of interest were largely
responsible for the disastrous performance of credit rating agencies in
assessing the risks of mortgage-backed securities, two former
high-ranking officials at [rating agencies] said Wednesday in
Congressional testimony.<br>
</div>
<br>
One of these executives said, "the business model prevented analysts
from putting investor interests first." The other said, "Profits were
running the show." What they meant was that most credit rating agencies
are paid by the investment firms that issue the instruments being rated. The rating firms are paid to give good ratings, and not to be too careful in their examination of the instruments. People and institutions buy risky bonds and instruments based on ratings that say the risk is low. And then boom!<br>
<br>
According to <a href="http://www.washingtonpost.com/wp-dyn/content/article/2008/10/22/AR20081…; target="”_blank”">an
article in the Washington Post</a>, Henry Waxman, chair of the House
committee, said, "Millions of investors rely on [the credit rating
agencies] for independent, objective assessments. The rating agencies
broke this bond of trust, and federal regulators ignored the warning
signs and did nothing to protect the public. The result is that our
entire financial system is now at risk."<br>
<br>
In other words, don't underestimate the effects of conflicts of
interest, or the breaking of trust they represent. And don't ignore the
warning signs in local government situations, such as arrogance, a lack of transparency, the failure
to fully bid out contracts, and constant denials that go against the
facts (current credit rating executives still deny that conflicts
impaired their firms' judgment).<br>
<br>
At the municipal level, conflicts won't destroy the world financial
system, but they can bring a city to its knees and undermine trust in
government for a generation. They can cost a city millions of dollars,
and even when they are brought out in the open, they can be very
difficult to fix. Just look at Chicago and Memphis, for example.<br>
<br>
Sometimes it takes bigger examples to make the point that conflicts of
interest are not minor ethical matters with little meaning in the real
world. We now know that our economy is effectively a confidence game.
Government isn't much different.<br>
<br>
Robert Wechsler<br>
Director of Research-Retired, City Ethics<br>
<br>
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