This is the Cato Daily Podcast for Tuesday, March 30, 2010.

I'm Caleb Brown.

Risky Assets Rated AAA played a key role in our financial crisis, but security

rating houses escaped much of the scrutiny

that accompanied the meltdown.

Cato Institute Chairman Emeritus William to Scannen believes that it starts with a major

conflict of interest.

Rating houses, he says, work for those issuing securities.

Well, they have overrated most of the mortgage-backed securities.

We did not know that at the time,

and it's not, it's only become recently clear why that was the case.

But let's back up.

The market for mortgage-backed securities

has two important conflicts of interest. The mortgage brokers who make the mortgages have the best opportunity to evaluate the quality of an individual mortgage, but they don't hold the mortgages.

They sell them to the investment banks who put together these mortgage-backed securities.

So the first, the people who make the mortgages don't have any skin on the game in that sense.

The second problem is the credit rating agencies work for the investment banks that issue the mortgage-backed securities.

So they're compromised up front.

And they have an incentive inherent in their relationship

to overrate the value of the credit worthiness of the mortgage-backed securities that these

investment banks sell around the world to all kinds of parties. Now it has only become recently clear why that has been increasingly a problem.

One is that basically everybody underestimated the increase or the fall in housing prices

...