Ratings Agencies and Real-Estate Appraisers: How Do You Keep ’em Honest?

Megan McArdle points to an interesting suggestion from Joe Wiesenthal at Clusterstock: form a pool of say, ten certified ratings agencies. When an issuer wants a rating, they are assigned an agency by lottery. They can’t go shopping for the best rating.

I’ve suggested exactly the same lottery-type system for real-estate appraisers. We’ve been hearing lots of stories about mortgage brokers selecting appraisers who will reliably give a (high) valuation that makes the loan look reasonable, with less-tractable appraisers getting squeezed out of the business. (I recently got an appraisal for a re-fi, and I truthfully have no idea how much credence to give that appraisal, which seems somewhat high.)

Interestingly, this randomization method has much in common with the method that emerged through evolution which prevents “selfish” genes from taking over and destroying the ability of organisms (and their other genes) to propogate long-term. (For a fascination if lengthy discussion, see Mark Ridley’s Mendel’s Demon.)

The random gene choice that occurs during meiosis means that a selfish gene can never “know” whether it’s wreaking its havoc on copies of itself. So it can’t win. Likewise, when randomization means that securities issuers and mortgage brokers can’t choose or even predict their ratings agencies/appraisers, they lose much of their ability to game the system, or damage the system as a whole.