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The Big Short Misleads on Ratings Agencies

The Big Short has captured rave reviews, not just from conventional critics but also from the likes of Paul Krugman. By featuring Hollywood heavyweights Ryan Gosling, Brad Pitt, Christian Bale, and Steve Carell, this exposé of the housing bubble and ensuing financial crisis was sure to gain attention. For his part, director Adam McKay does a great job keeping the plot moving forward while accurately conveying the essentials of the Wall Street and commercial lender shenanigans.

The Big Short leads viewers to believe that shortsighted greed is the ultimate explanation for why the ratings agencies gave their blessing to dangerous products.

The movie was surprisingly entertaining, given the dry subject matter, and I was impressed at the level of detail. Furthermore, fans of free-market economics should cheer any movie that can make short-selling speculators, of all people, look cool.

But the movie blames market forces without looking to the role government intervention played. FEE.org’s Jeffrey Tucker points out, for example, that The Big Short fails to mention the role of the Federal Reserve and the various federal government policies that promoted unsound mortgage practices. I’d like to focus specifically on the role that the ratings agencies played.

Derivatives and the Ratings Agencies

The Big Three credit ratings agencies are Moody’s, Fitch, and Standard & Poor’s, which together account for some 95 percent of the market. They were an essential part of the housing boom and bust. To understand their contribution, we need briefly to review the historical context.

From 2002 th…

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