The concept of a free market rewarding good behavior and punishing bad has taken a beating in the media lately, but there’s been far less discussion about the failures of various government regulators to protect consumers from harm. A 68-year-old retired lawyer in California is suing the three biggest credit rating agencies – Standard & Poor’s, Moody’s and Fitch – for the loss of a $40,000 investment in Lehman Brothers, according to Bloomberg.com. On Sept. 15, 2008, the day Lehman filed for bankruptcy, all three rated Lehman’s as a high-quality, low-risk investment. They were all spectacularly wrong. Yet the Security and Exchange Commission (SEC), which regulates these credit rating agencies, still forces private banks and money market fund managers to rely on their now highly dubious ratings.
The three rating agencies control 98 percent of the debt market in what American Enterprise Institute resident fellow Alex Pollock calls “an SEC-created cartel.” After being paid lucrative fees by companies they rated, they were totally blind-sided when some of the companies imploded. In July 2007 – more than a year before Lehman’s and Merrill Lynch went belly-up – credit default-swap traders had already tagged them as junk, Bloomberg reported, even without the insider information credit rating agencies are privy to. Yet these agencies are now monitoring $450 billion worth of taxpayer-backed bonds.
The failure of government regulation also extends to basic consumer law, according to University of Chicago economist Omri Ben-Shahar, who argues that consumer protection laws don’t really protect consumers. Delivering the university’s annual Ronald H. Coase lecture in February, Ben-Shahar argued that mandatory disclosure laws are often useless in determining whether a product is good or not. Even if a product gets a worthless credit-rating, only wealthy consumers are able to exercise their legal rights in court. Furthermore, some product liability lawsuits filed by unscrupulous attorneys unfairly target deep-pocketed companies that make good products, making litigation a poor mechanism to determine which are which.
Relying on a company’s reputation, which is essentially a market reaction to its corporate governance and product quality, is a better way to keep from making a mistake than relying on either consumer protection laws or the courts, he concluded. So as far as consumer protection is concerned, it seems that the age-old warning -caveat emptor or buyer beware – still applies.
