The Political Tide Against the Ratings Agencies
The bane of our pseudo-capitalistic system is the blatant double standard that is upheld with respect to prices. If the money prices of things go up, that’s ok, and the saint behind this wholesome circumstance is typically elevated to greatness. However, if the money prices of things go down, there’s got to be a bad guy somewhere — and boy does he get hanged, drawn and quartered in the town square.
The ratings agencies are a group that has experienced the extremes of both worlds; during the upswing, they were the very standard of financial wizardry, and even rose to the status of being enshrined in the law. However, more recently, they’ve gone from being the ‘greatest’ to the latest victim of the barrage of hate flowing from the vocal cords of our public orators. Here, I try to shed some light on the seemingly convoluted subjects of the capitalistic price system, the notion of risk and regulation.
The Irony of Well-Established & Popular Ratings Agencies:
First of all, just to emphasize that I have no particular attachment to the rating agency companies, I should mention that the notion of a prominent and popular ratings agency is oxymoronic.
Risk is a peculiar subject that is scarcely understood by the herd. Safety in speculative financial assets is not found in those assets with the smallest historical variance from the mean (i.e. the smallest volatility), indeed, it can hardly be any demonstrable function of any past data. Rather, it is a function of matters that the herd cannot possibly accept. Safety (or a profound lack of safety) is found in those assets where consensual opinion is confused yet dogmatically convinced about a specific future. Hence, as I explained here, consensual conceptions of risk tend to defeat themselves. Consequently, we can say that any ratings agency that reaches the status of a large and well-respected institution is bound to get it wrong at the worst possible times. In short, the concepts of ‘accurate risk attribution’ and ‘popularity’ are mutually incompatible.
The Symmetry in Financial Markets: Exploding the ‘Up is Good, Down is Bad’ Fallacy:
As I often mention here on greshams-law.com, financial markets are ‘just’ arenas where people go to swap stuff. Forgive me for hammering the point home here, but stock markets are arenas where people go to swap stocks and money, commodity markets are arenas where people go to swap commodities and money, bond markets are arenas where people go to swap bonds and money… In this way, the thing and the money stand as equal counterparts in the arrangement. So, to praise prices rises as a fundamentally lovely thing, and to condemn price falls as an inherently dastardly thing is to commit a rather simple, yet frequently overlooked, double standard.
I am sure that a few may respond with; ‘the great thing about prices rises — especially in the stock market and/or in risk assets in general — is that the wealth effect is ignited in the economy’. This may be true, but it cannot escape the rudimentary simplicity of the principle above. All that can be said is that a proportion of market participants succumb to an illusion. A rise in the price of — say — the stock market, is (to be sure) good for the holders of stocks, but it isn’t good for the holders of cash!
Symmetry in the Effects of Ratings Agencies:
Something that has been bemoaned as a failing of the ratings agencies has been the tendency for downgrades in credit ratings to increase the swiftness with which prices decline. Such wails of woe are subject to the ‘up-good, down-bad’-fallacy described above. With the unviability of ratings agencies aside, we have to note that the effect of their ratings (and changes in ratings) work both ways. Just as downgrades have a tendency to worsen sell-offs, the upgrades had the tendency to exacerbate the buying sprees! Of course, politicians, arguably one of the greatest proponents of the ‘up-good, down-bad’ fallacy have come out all-blazing against the ratings agencies. As The Independent reported this morning:
The Leading credit ratings agencies were threatened with tighter regulation and break-up yesterday by some of Europe’s most powerful politicians.
The German finance minister, Wolffanf Schauble, said he could see no justification for Moody’s recent downgrade of Portugal’s debt and believed that limits should be put on the rating agencies’ “oligopoly”…
Jose Manuel Barroso, the president of the European Commission, claimed Moody’s downgrade of Portugal added to speculation in the markets and suggested an anti-Europe bias. The European Union, he said, planned to strengthen regulations overseeing the three majors, and said European legislators would also look into issues of “civil liability” for incorrect judgments by agencies on the credit worthiness of sovereign European nations, with an obvious focus on those currently under pressure – …
… The Greek foreign minister, Stavros Lambridinis, said the agencies’ actions in the debt crisis had been “madness”. The fierce attacks on the agencies’ integrity came after a shock downgrade of Portuguese debt to “junk” status by Moody’s sent stock markets and the euro sharply down, and sparked fears of another round of contagion.
Well, it looks like even politicians are wearing their conspiratorial hats now – the rating agencies are out to get them… Unlike us, however, they don’t put their money where their mouths are!
Regulation ad infinitum…
The unfortunate thing about the quote above is that there is an almost idiotic denial of reality involved. As Ayn Rand demonstrated in all of her fantastic novels, you can’t force people into success (with the gun). Moreover, you certainly cannot force people into being correct in their endeavors as futurologists! The whole concept of risk is based on the fact that the future is unknowable, so to attempt to regulate that out of existence is just incredibly silly! If they have failed for lack of inhuman characteristics, how is further regulation by humans going to help?
The financial markets are symmetrical – upward moving prices do not remarkably accumulate loveliness. Moreover, all that is required to regulate the activities of market participants is the simplest thing in the world – the market.
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012