The blogger Aaron Bady, who goes by the name Zunguzungu, has an interesting post up about Standard & Poor’s, the credit-rating company that just knocked down its rating of U.S. government’s creditworthiness after years of drastic errors about the value of mortgage-backed securities—errors with devastating consequences for the banks that took them seriously, and therefore for the global economy. He notes that The New Yorker’s James Surowiecki cast a skeptical eye upon the agencies almost two years ago:
The rating agencies’ role in inflating the bubble is well known. Less obvious is their role in accelerating the crash. Agencies have typically resisted changing their ratings on a frequent basis, so changes, when they occur, tend to be belated, widespread, and big. In the space of just a few months between late 2007 and mid-2008 (after the housing bubble burst), the agencies collectively downgraded an astonishing $1.9 trillion in mortgage-backed securities: some securities that had carried a AAA rating one day were downgraded to CCC the next. Because many institutional investors are prohibited from owning too many low-rated securities, these downgrades necessarily led to forced selling, magnifying the panic, and prevented other investors from swooping in and buying the distressed debt cheaply.
A few months ago, Propublica’s industrious investigative reporter Jesse Eisinger was also among those who wondered aloud about Standard & Poor’s reliability:
As everyone knows by now, the credit ratings agencies played an enormous role in creating the conditions that led to the financial crisis. Their willingness to slap triple A ratings on all manner of Wall Street-engineered mortgage rot was enormously lucrative for the raters but a disaster for the global economy.
Then comes yesterday, and an august decision by S&P is worldwide news, with what consequences we shall see in the coming days, weeks, months, and years.
I am not a specialist on ratings agencies. Oh, am I not a specialist on ratings agencies. I’m not saying that Standard & Poor’s is always wrong. (Or right.) But I have a more general skepticism. I can’t help wondering why our news media treat ratings agencies as nature’s own foolproof, built-in thermometers. Would it not be interesting to help followers of the news understand what a ratings agency is, why it has come to have credibility, and how good its record is? What should we make, for example, of the fact that S&P has downgraded American credit but Moody’s and Fitch have not? I don’t pretend to know. But the question is surely part of the story of what it means that AAA sank to AA+.
I argued the other day that experts like Alan Greenspan and Arthur Laffer don’t deserve a free ride. Their gross errors ought to be part of any story that cites them. Well, ratings agencies are the same. They are human enterprises, fallible institutions—and like other institutions, they have procedures, interests, and histories. Their records deserve inspection. In the scientific spirit, in the spirit of show me, they deserve scrutiny.
Perhaps I pass myself off as a bit too modest. A number of years ago, I wrote a study of the television entertainment industry, which included an attempt to figure out what Nielsen ratings and other network research were good for, given the fact that some of the most successful shows in the history of the networks (most famously All in the Family) had been rated poorly by test audiences. Nielsen was famously close with its data, but the most interesting thing I discovered was that network executives didn’t really care. For their purposes, the ratings didn’t have to be accurate. They had to be good enough to settle an argument, good enough to support hunches, good enough to brandish in a meeting, good enough to silence skeptics. Good enough. In other words, they’re material for decision-making purposes—deemed better than nothing for the purpose of shoring up confidence that the networks made good decisions.
Toward the end of making them seem features of nature, ratings agencies promote their ratings, which are, after all, their products. They market them as the holiest writ they can. Having won the confidence of various players, they pyramid this confidence into more confidence, in a sort of confidence game. It’s been argued, in fact, that one cause of the housing bubble was the effort of one ratings agency to promote its own quantitative measure of creditworthiness worldwide. (The argument by Martha Poon is a bit technical but repays study.)
All this should be taken on when ratings themselves, in all their apparently coldness, hardness, and impersonality, are The Story.
