
Inflated Bond Ratings Helped Spur the Financial Crisis. They’re Back - chibg10
https://www.wsj.com/articles/inflated-bond-ratings-helped-spur-the-financial-crisis-theyre-back-11565194951?mod=rsswn
======
raven105x
There is so much armchair theory and bullshit surrounding economics
(especially in the news) that it's hard to tell what's valid anymore.

~~~
cbanek
Valid is hard to tell in economics, because economics isn't really a science.
More of a social science. A lot of people have debated this point before, but
even at a theory level, it imagines people as rational actors, and we know
they are not always, and sometimes not ever.

~~~
rahimnathwani
"even at a theory level, it imagines people as rational actors"

There is a whole field of economics ('behavioural economics') that explicitly
doesn't make this assumption.

~~~
sprafa
That’s the only scientific part about it but afaik it still only applies to
micro not macroeconomics.

To quote Charlie Munger: “it economics is not behavioural, what the hell is
it?”

~~~
TheOtherHobbes
Politics. Economics is _persuasion_. It's about some people telling other
people how they should act "because".

It's not descriptive or empirical, and never has been.

The more honest economists will tell you it's considered part of moral
philosophy.

~~~
arethuza
I can recommend the book "Licence to be Bad: How Economics Corrupted Us" by
Jonathan Aldred - it makes a pretty strong case that the way economics has
influenced politics over the last few decades has had a pretty strong negative
impact on society:

[https://www.goodreads.com/book/show/43267091-licence-to-
be-b...](https://www.goodreads.com/book/show/43267091-licence-to-be-bad)

------
lossolo
From the comments:

"Moving to dismiss the suit in a California federal court, S&P said that
reasonable investors would know its assurances of independence were just
marketing, and that its ratings should be treated as free speech, not as
financial statements." [https://qz.com/101722/sp-amazingly-says-no-one-should-
believ...](https://qz.com/101722/sp-amazingly-says-no-one-should-believe-its-
ratings-are-independent-and-objective/)

~~~
wahern
> like a used-car salesman who tells you the last owner of your car was an old
> lady who only drove it on Sundays.

Wow, that's literally what the salesman said when I bought my first used car.
And I believed him, because of the low miles.

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drawkbox
One pretty solid indicator of recessions to the year or two is the inverted
yield curve on short and long term yields. From the FRED: 10-Year Treasury
Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y) [1].

Once it dips and inverts, recession seems fairly consistent. Nothing is ever
guaranteed but it is better reliability than most financial media, though the
possible inverted yield curve is getting attention [2].

Machines and A.I. run it mostly now though, so game theory is now in
their/algorithms hands. We are mere spectators in the speculative simulation.
They are definitely watching for an inverted yield curve.

[1]
[https://fred.stlouisfed.org/graph/?g=lFt2](https://fred.stlouisfed.org/graph/?g=lFt2)

[2] [https://www.bloomberg.com/news/articles/2019-08-05/yield-
cur...](https://www.bloomberg.com/news/articles/2019-08-05/yield-curve-blares-
loudest-u-s-recession-warning-since-2007)

~~~
melling
I read somewhere that this only seems to be an indicator for the United
States.

For the rest of the world it has not been a predictor. Unfortunately I can’t
remember where I saw the article in the past day or two.

~~~
antupis
German is already entering to recession so the rest eurozone will follow very
soon. [https://www.theguardian.com/world/2019/aug/07/german-
industr...](https://www.theguardian.com/world/2019/aug/07/german-industrial-
production-suffers-amid-us-china-tension)

Also Chinas economy is slowing down but the problem is that probably nobody
knows how much.

~~~
noitsnot
There are a number of countries cutting interest rates to attempt to help
their slowing economies.

[https://finance.yahoo.com/news/india-delivers-
rare-35-basis-...](https://finance.yahoo.com/news/india-delivers-
rare-35-basis-061505034.html)

[https://finance.yahoo.com/news/brazil-cuts-
rates-6-amid-2118...](https://finance.yahoo.com/news/brazil-cuts-
rates-6-amid-211813450.html)

------
basementcat
Is there a market opportunity for completely automatically generated security
ratings? Individuals in most developed countries are now assigned a completely
computer generated "credit score" (from payment history and applications for
credit); is it much more difficult to algorithmically assign an analogous
score for a bond or similar instrument?

EDIT: Or is the problem a misalignment of incentives? It appears that
investment rating providers are paid by the managers/sellers of the securities
rather than the prospective buyer of the securities. This may create an
incentive to attract more business by inflating ratings. If prospective
investors paid for the ratings, perhaps there would be a different incentive
alignment (and also possible opportunities for tragedy of the commons).

~~~
lefstathiou
I was a former ABS banker and I personally think there is an opportunity to
automate the structured finance ratings process.

Here is how it works today. An originator finds people to lend to, aggregates
them, works with a bank to structure them into a security that gets rated and
then institutional investors buy the securities. Rating agencies get paid to
apply their ratings criteria which they publish, allowing you to reverse
engineer the model.

The opportunity, in my opinion, is a point of sale system where you hand iPads
out to car dealerships, clinics whatever. Someone wants to make the big
purchase, puts their social in and gets funded by the institutional investors
on the spot. An institutional investor at the moment won’t get a say on
funding, the platform will. They will simply set their high level criteria and
the system will continue funding to get to some average that fits it.

For example, I could be an investor that says I want $10mm of subprime auto
loans per month with average FICO if 615 and min/max loan sizes of XYZ. That
gets entered into the system and then the dealerships continue handing iPads
at the point of sale. The cash flow of the loans can move through the
waterfall and ratings can be real-time in the flow as opposed to the security.

Anyway not sure if this makes sense as it is nuanced and I am being high
level.

~~~
jfengel
The problem is that this doesn't track correlations between people. The
implication is that each user has an independent risk, but that's not always
true. In particular it was the problem with CDOs during the last crisis:
people assumed that one person's default would not cause another's, and what
seemed like a collection of moderate-risk loans was actually very high risk in
aggregate.

If you're aware of that fact then you know what you're getting and can deal
it. But it's the tacit assumptions, magnified by aggregation and automation,
that caused a disaster.

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aussiegreenie
There are at least three debt markets that will cause problems.

1\. Student Debt - It is non-renounceable. Bankruptcy does not clear it.

2\. Oil and gas companies - the entire "fracking revolution " has been funded
by loses from bondholders.

3\. All Private Equity debt - the basic business model is broken.

~~~
jedberg
You forgot car loans. A few years ago my wife was offered an 84 month loan
when she was unemployed. Very few people keep a car for 84 months. I'm sure
there will be a lot of people underwater on those loans pretty soon.

~~~
dylan604
are you not underwater immediately on any car loan? sure it's worse on 84
months, but the old saying about "once you drive it off the lot" would apply
to any loan would it not?

~~~
fingerlocks
This is only true in the short run for new vehicles. A well-maintained vehicle
will hold a significant amount of value after 10+ years. And if you are
fortunate or savvy enough to buy a car that will obtain “collector” status you
may even make a nice profit. One extreme example is the 86’-91 Volkswagen
Vanagon Syncro, which can be sold for up to $90k today.

A more common example is the first generation Toyota Tacoma (00’-04’) that is
currently going up in price, I’ve seen closing prices at $15k in the last
year. Small trucks are now extinct and this particular model is proven to be
absurdly reliable, but who would have predicted that 10 years ago when these
were selling for $3k-$5k?

~~~
dsfyu404ed
Your examples are trendy vehicles that have hordes of fools lining up to pay
multiple grand for examples that can't even move under their own power. Nobody
in their right mind would say that classic VW vans or any Toyota pickup is
indicative of market patterns in general. They are what the "cool kids" drive
and pricing reflects that.

Diesel trucks used to be grossly overpriced too but now that most of the older
stuff has aged out and the "new enough to still be kinda nice" market segment
is full of emissions era diesels the crazy pricing has mostly gone away.

~~~
fingerlocks
Wow a little harsh, don’t you think? Maybe I should have used the Toyota
Corolla instead? These weren’t trendy vehicles when they were new, that’s my
point. Perhaps you missed the part of my comment where I prefaced with “If
your fortunate...”? Because obviously this was an off-topic side comment
countering GPs generalizing that all cars necessarily lose value, not a strong
claim about the market as a whole.

~~~
dsfyu404ed
I can't speak to the VW but the Tacoma was absolutely trendy when new. From
2000 or so to present it has been the official pickup of "I don't 'need' a
pickup but I make good money, I like nice things and I want a pickup" (I'm not
saying there's anything wrong with that reasoning). They've always (even back
to the 80s and 90s) been more expensive than the alternatives when new so only
people who are dead set on them tend to get them.

They're comparable to the Jeep JK and the WRX STI or a performance trim
Mustang/Camaro but for different demographics. Anyone could tell you that they
would hold value better than average when new.

Losing less value than average is not all that remarkable. Gaining or failing
to lose value is exceptional and subject to the whims of consumer culture (see
my tangent about diesel pickups). Jeep Wranglers used to be like that but as
the 4dr JKs hit the used market it calmed down a lot. Old full size Broncos
are probably about to stop losing value if the rumors of a new fullsize are to
be believed.

Also I toned down the language in the original a little.

~~~
fingerlocks
Are you sure you're not mistaking it with the later post-2004 models? The
early model MSRP'd at <$20,000 ($26k today infl. adj.) and was a small pickup,
nothing like the full-size $45k beast that is offered today. It would be odd
to compare it with the $35k WRX STI.

Anecdotally, I purchased a used Tacoma in 2011 for a few thousand dollars as a
family workhorse vehicle. I sold it for nearly double five years later with
only making regular oil changes. This really changed my impression of the used
car market and have since started a side hobby buying and restoring "almost-
classic" vehicles.

~~~
dsfyu404ed
I'm not comparing it in terms of cost, I'm comparing it in terms of how buyers
think about it. People buy a WRX STI not because they don't know what they
want and it seems reasonable. People don't buy a WRX STI because they want a
sedan, do a bunch of number crunching and decide it's the best fit for their
needs. People buy a WRX STI because they're in the market for a sedan and they
want a WRX STI. The same is true for the Tacoma and a whole host of other
vehicles. People buy a Tacoma because they specifically want a Tacoma and they
pay out the nose for it (especially if buying used).

------
hugofirth
This might be stupid - but why are these credit ratings agencies allowed to
exist in a comparatively free market? Surely a function like the one they
provide is better handled by a Not-For-Profit governmental body?

Without this - or incredibly tightly policed regulation of the existing
private agencies, I don't see how an outcome like the one described here isn't
mathematically guaranteed?

~~~
tim333
> why are these credit ratings agencies allowed to exist...?

Are you going to ban people from giving opinions as to whether various
investments are good or not? As well as being anti free speech it would make
life harder for investors. However I guess you could have a government
controlled agency in parallel. Or regulate the agencies that their ratings
have to be reasonable to get a license and ban/fine them if they are giving
AAA ratings to junk.

~~~
hwillis
> Are you going to ban people from giving opinions as to whether various
> investments are good or not?

We already do basically do that for legal and medical advice.

~~~
rcxdude
And it is regulated in the financial space as well.

------
gniv
> Sometimes one firm called a security junk and another gave a triple-A rating
> deeming it supersafe.

Doesn't this suggest that the ratings are providing close to zero signal?

~~~
patio11
Insufficient information to judge that to be the case; they rate millions of
bonds and, statistically, they’ll almost certainly have every type of
disagreement occasionally. The difference between AAA and junk isn’t 99 and 3
on a 100 point scale; it is somewhere in the neighborhood of 99.9 and 96.0 on
the 100 point scale “Likelihood to not default within 1 year.”

You’d need vastly more data points to firmly believe the conclusion “Their
ratings are indistinguishable from being randomly generated.”

There are people on Wall Street who can appreciate this math. A statement
which is true and necessary but may not be kind: Wall Street does not allocate
their talents towards producing journalism.

------
rolltiide
There’s nothing else to invest in though.

If investment grade bonds are all crowded overvalued trades then you have to
go further out on the risk curve.

If the market is slow to do that then the rating agency will just start
inching ratings up and lowering criteria

------
Mizza
Now there's an understatement. It's a completely fraudulent industry.

EDIT: It's also one that's ripe for a good and proper YC-unicorn style
disruption. Hit me up if interested.

~~~
H8crilA
How do you know that?

~~~
Mizza
..weren't you there for the crash?

[https://en.wikipedia.org/wiki/Credit_rating_agencies_and_the...](https://en.wikipedia.org/wiki/Credit_rating_agencies_and_the_subprime_crisis)

The article even spells it out - they haven't changed their business model
since. Bank needs a rating on a asset, but their incentive is to get a
"better" rating, not a more honest one. There are multiple agencies, so banks
shop around for the most favorable one. So, as soon as one agency loosens
their ratings, they all follow suit. They sell good ratings. That's the
industry.

Quote after quote:

The Financial Crisis Inquiry Commission (FCIC)[39] set up by the US Congress
and President to investigate the causes of the crisis, and publisher of the
Financial Crisis Inquiry Report (FCIR), concluded that the "failures" of the
Big Three rating agencies were "essential cogs in the wheel of financial
destruction" and "key enablers of the financial meltdown"

U.S. Securities and Exchange Commission Commissioner Kathleen Casey complained
the ratings of the large rating agencies were "catastrophically misleading",
yet the agencies "enjoyed their most profitable years ever during the past
decade" while doing so.[41] The Economist magazine opined that "it is beyond
argument that ratings agencies did a horrendous job evaluating mortgage-tied
securities before the financial crisis hit."[42]

According to columnist Floyd Norris at least one rating agency—S&P—responded
to the credit crisis by first tightening up its standards and sacrificing
market share to restore its reputation,[83] after which it loosened standards
again "to get more business",[84] tripling its market share in the first half
of 2013.[85] This is because, according to Norris, for rating franchises to be
worth anything, they must seem to be credible to investors. But once they
overcome that minimal hurdle, they will get more business if they are less
critical than their competitors.[84]

and on and on and on.

~~~
_jal
I still think ratings agencies, if their ratings are to be required, should
have money where their mouth is.

There are a number of ways this could work; one is they issue a contract
redeemable for the difference between their predicted performance of a given
company and the actual performance.

If they're as good at this as they think, they get another revenue stream. If
not, the victims of their conflicts of interest have some insurance.

------
nullwasamistake
Is this a hit piece on smaller ratings agencies?

For example, the only charts on the page show how smaller agencies give higher
grades on average. What does this have to do with risky asset vehicles
exploding in popularity? Not much.

There are many obvious explanations to this that the article doesn't even
mention. Like how a slightly lower rating from a bigger agency may still carry
more weight, skewing ratings higher the smaller the agency.

The article mentions several times that additional ratings agency competition
has made things worse. And that doesn't make any sense, investors now have the
ability to choose who they believe.

The bond inflation part of the article is believable, but the focus on
comparing agencies to eachother is suspect to say the least

------
ripvanwinkle
Is it time to have a federal agency assign debt ratings.

After all we don't let the pharmaceutical companies determine if a drug is
safe.

The feds may well outsource ratings to private companies but those companies
are no longer beholden to the issuer of the debt.

~~~
0x8BADF00D
Yeah, that’s what we need. More government to guarantee that bonds are good
when they’re actually shit. The Federal Reserve already does a fine job of
that. After all, US treasuries are AAA, right?

------
znt
The Coming Bond Market Collapse: How to Survive the Demise of the U.S. Debt
Market - Michael G. Pento

This is a good read if you'd like to have an understanding on what's coming up
next.

~~~
Buttons840
That book is 6 years old.

~~~
mooreds
"Economists have predicted 9 of the last 5 recessions."

~~~
thesagan
Like politicians, smart economists wait to make predictions—growth or
recession—until two quarters later.

As a group they miss acute macro moves, altogether.

------
cryptozeus
These ratings are not cause but the side effect of how much of a crisis this
financial system is already in.

What about the incompetent companies giving these ratings?

------
H8crilA
For those that believe rating agencies are garbage: what bonds do you keep in
your portfolio?

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formercoder
Tricky problem to solve. Maybe we don’t need ratings at all. Investors should
simply perform their own DD on any deal as they naturally would. We can still
rank companies on factors like leverage and coverage ratios for comparison
purposes.

~~~
tbrownaw
The trouble is when they're managing money for other people who done have a
say - pension funds or whatever - and the government wants to have some way to
regulate them. Because _not_ restricting then from "dangerous" things would
bad, whether or not it actually helps. (And with the way things went bad when
the regulation stopped working, maybe it even _does_ help?)

------
im3w1l
Who is the buyer of these questionably-rated bonds? Passive bond funds?
Pension plans?

~~~
H8crilA
Pretty much everyone who has bonds relies on credit rating. In particular on
the "investment grade" rating.

How do you buy bonds?

~~~
im3w1l
Well my (shallow) understanding is that some entities are required to buy
bonds of certain rating because of regulatory reasons or because that's what
they promised investors. Other entities may not have such requirements but do
rely on the rating because they don't have the resources to check the
creditworthiness. And yet other entities may disregard the rating entirely and
solely put their faith in their own analysis.

If I bought bonds myself I certainly wouldn't trust the rating. I'd only use
it to serve as an indicator of how likely I can find a "greater fool"

~~~
H8crilA
So you have zero bonds in your portfolio? Directly or through funds
(mutual/ETF).

------
acd
We should go back to free banking. The current model privatizes profits but
shares losses on the public.

There is no regulation that will fix the current system it is broken in its
design.

I hope there will new banking through crypto currencies which work also for
the environment.

If this was a app/provider outage and we would do a root cause analysis we
would determine that monetary centralization is the root cause issue.

