The Ebert Threshold
September 19, 2009, 1:23 am
Filed under: Uncategorized | Tags: , , , , , , ,

One favorite set of punching-bags when it comes to amateur-diagnosing the causes of The Financial Crisis (tm/2008) are the rating agencies (Moody’s, S&P, Fitch). In this beloved storyline, everything was just fine, but the rating agencies got too much in bed with the banks, or all simultaneously made bad computer models, or something, and gave too many AAA ratings, and that caused a huge portion of the trouble. The moral of the story, supposedly, is Better Regulation And Oversight Of The Rating Agencies.

Let’s try an analogy.

Suppose Congress codified it into law that movie theaters could charge twice as much for any movie that Roger Ebert gave ‘three stars’ or higher. In other words, Roger Ebert – the movie critic – is specifically mentioned in the bill, and given a sort of official, government-approved fiscal power to help determine movie-ticket prices by the sheer force of his proclamations.

First off: wouldn’t that be freaking ridiculous? Yet that’s what we have done with The Rating Agencies. Their proclamation that a security is “AAA”, for example, affects the legal capital requirements needed to be held against it. This fact alone is pretty much the only reason that “CDOs” even exist.

But back to the Ebert rule. Okay, so if the movie gets 2.5 stars or lower, you can charge $10; 3 stars or above, you can charge $20. Now along comes some enterprising theater owner who takes Transporter 2 (2.5 stars), splices a half hour of Schindler’s List (4 stars) onto the end of it, and calls the resulting 2-hour film a 3-star “movie” (on average). Now he can charge $20 per 2-hour bloc instead of only $10 for every 1.5-hour bloc, which is a nice improvement from his point of view.

This begins to happen more and more. Movies are spliced and diced just to get above the Ebert Threshold. Four-star movies are cut off by 25% and called three-star movies for the same price (to watch the last 25% you have to buy another ticket). Finally, movie studios start getting in bed with Ebert and sending him kickbacks, leading to Star inflation. People complain about all this. “This is absurd!” they say. And it is.

Now, the interesting question is why it’s absurd. I’m not sure there’s a right answer and there seem to be two general schools of thought:

1. It’s absurd because Roger Ebert shouldn’t be allowed to just give four-stars to any movie. Or to get kickbacks from movie studios. Generally, there needs to be better and stricter oversight of Roger Ebert. He should be called before a Congressional subcommittee. Meanwhile, there should be tighter controls, and more complicated mathematical formulas, regarding how a “three-star-on-average movie” can be created. Not just any movie can be sliced and diced like that. Some independent body should do some stress-testing of their own, perhaps, hiring the best PhD statisticians to build models of Movie Quality. Maybe the theater owner should be required to fill out more forms, pay some fees, take some licensing exams, etc. An independent regulatory body, with Presidential appointees ratified by Cognress, could be set up to oversee all this.

2. It was just absurd to give Roger Ebert’s movie reviews the force of law in the first place.

Back to The Financial Crisis, seems to me that the people who go around saying ‘the rating agencies need better oversight! that’s the whole problem!’ are Type 1 People. They see a problem that was created by a weird, bizarre regulation and think the answer is better regulation. In my view this sets up an inevitable game of whack-a-mole as inevitably Clever Regulation N+1 becomes necessary to patch up the holes people have found in Clever Regulation N, but whatever.

I guess it’s obvious I’m more of a Type 2 Person myself. I really don’t understand the Type 1 mentality at all. But maybe that’s just me. Like I said, there are no right answers here. Both approaches 1 and 2 are equally rational and defensible.


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