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Would you credit it?

December 22, 2011

I’ve been trying to get to the bottom of the reflexive anger and irritation I feel at the influence that the credit rating agencies have been having recently. [Anyone acquainted with me will know by now that those two responses are the ones most likely to determine whether I write a post, or just ruminate].

These few thoughts are written from a position of relative ignorance. So, without  having to cover this by resorting to out-and-out humour, I’m going to make a virtue of my naivety.

I think I’m now clear what bothers me. It is the fact that institutions which are themselves just analysts (not public bodies, not money risking investment institutions) can have a significant effect on the thoughts and actions of sovereign governments just by, themselves, thinking aloud about a decision that they may be going to make in the future… about those governments’ credit ratings.

I would have thought that the primary purpose of a credit rating agency was to reflect reality as it stands. I don’t mean they shouldn’t be analysing the future. But when they’ve done that what matters, assuming it matters at all, is the rating that they assign to an institution right now. That’s what I’m supposed to look at, today, when making a decision about buying somebody’s debt. The agency is telling me how good that somebody is, for paying me back in the future.

I should say, there’s still a nagging doubt in my mind about the function that credit rating agencies actually perform. If you accept the market-based frame of reference in which these agencies are embedded, then the market is supposed to be an extremely efficient, emergent way of rapidly sharing information, calculation and sentiment about the value (and future value) of anything. If the market works as it is supposed to do, and is preferable to any other way discovered or attempted by humanity to allocate resources efficiently amongst even non-specialists, why do we need credit rating agencies at all… to compete with the market’s own signals? I have to suppose that the answer is that they are a facility for people who don’t have the time or disposition to read the market for themselves.

So let’s make that the case. These agencies are summarisers – boiling down the complex and shifting wisdom of the markets into a few simple indicators. Now – how do they make money?

They obviously can’t make money out of the big headline data that they put into the public domain… simply because we can all self-serve for those. These must be shop window dressing; evidence of the enduring and respected status of the agencies in the matter of BIG THINGS, thus tempting us inside to purchase more comprehensive and detailed data, and analytical consultancy, in these matters and also those of much smaller enterprises. Again – what we would pay for in these circumstances, is what the agency thinks now about the data and analysis it has compiled. That may include what it thinks now about the future. But I can’t imagine paying for a story about what the agency thinks it might be going to think, differently, in a few days’ time.

So why do the likes of Fitch issue statements about what their ratings might be going to be? Why do they do this about those big headline figures which, if I am right, are their shop window dressing?

I can only think of two reasons. The first is competition amongst themselves, and the second is a more common concern about the reputation of the entire credit rating sector.

The latter took a beating as a result of the big bank crashes. The agencies were criticised for ‘not seeing it coming’. So now, we are told, they are trying to show their ability to anticipate major volatile shifts. But, if my points above are right, you demonstrate this simply by being right… i.e. the rating you set NOW turns out to have been a correct assessment of risk, and then a little while later the rating you set NOW turns out to have been good, and NOW… and… NOW. Surely you can’t improve on this, regarding your reputation for foresight, by speculating about your own future beliefs and pronouncements. [If it’s anybody’s business to do that it would be a Credit Rating Agency Rating Agency!!!]

So that leaves us with the former. Presumably the agencies compete with each other for all that paying business further down the food chain. So could it be that they are competing for the highest perceived influence, by demonstrating their ability to provoke statements, or even actions, from the finance ministers of nation states… simply by speculating about what they might themselves be going to say and do? Incidentally, this future-self-speculation is the only commodity they can afford to wager in such a game. The actual ratings themselves, and the consequences of getting them more wrong than necessary, are too precious to hazard.

I think that must be it. Fitch and their peers make statements about their own possible future decisions – partly in a logically flawed attempt to repair the standing of their profession, but primarily as an exercise in PR and competition, to show who has most clout… in order to win business.

This is wrong!

Three reasons:

  1. Because the decisions that governments make, in part conditioned by this public dialogue, affect the well-being and life chances of millions of people, possibly even the stability of some states. It seems totally disproportionate for a (quite small?) bunch of competing analysts to be able to influence those decisions more than, say, electorates do.
  2. If the much vaunted market really is the best resource management tool going – then the ratings agencies’ superimposed judgements are actually obscuring and distorting the ‘pure’ signals of the total market
  3. If it is the job of the agencies to analyse and rate the current situation, i.e. to reflect what the market is trying to tell us, then these public announcements introduce a feedback loop which free market/liberal economists should be experiencing as the most piercing of Hendrix-style screams. How can the agencies plausibly interfere in that which they are supposed to dispassionately describe?

I think that will do for now. I feel better. I guess for me it’s philosophy rather than economics.

What do you think?

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