
The horrifying AAA debt-issuance chart - MaysonL
http://blogs.reuters.com/felix-salmon/2011/07/15/the-horrifying-aaa-debt-issuance-chart/
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jellicle
Author doesn't really understand the situation.

The problem, which started becoming visible in 2001, is that in the aftermath
of the "dot-com boom", the ratings agencies starting rating a lot of things
AAA that were not, in fact, AAA. That is not "an excess of overcaution". In
fact it was an exploit of the banking/finance system, that went like this:

    
    
        -- lots of places are required by law or regulation to only invest in AAA securities, because they/the public don't want to lose any money.  They have a LOT of money to invest.
        -- but they don't check the shit themselves
        -- they depend on a rating agency
        -- ratings agencies are paid by the issuers
        -- they are exploitable
        -- bribe the rating agency to give my shit a AAA rating, and now I can sell a ton of it
        -- offer the investor a slightly greater than AAA return, and they love it
        -- everyone is happy: rating agency is bribed, investor is getting better returns than expected, and I can sell all the shit I can package up
        -- until it all falls apart.
    

And the far right side of the chart is just a continuance of the same thing:
our shit fell apart, what should we do? Well, the easiest thing is to bribe
the politicians to take our private debts and turn them into public debts. And
so it happened. That big tall lavender bar in 2009 is the dark purple lines
from a few years prior....

None of this has anything to do with an excess of caution or with AAA debt
being more systemically dangerous than other types of debt. The blogger here
almost grasps what is wrong:

> "That’s possibly the most horrifying bit of all: it simply defies credulity
> for anybody to be asked to believe that more than half the bonds issued in
> any given year are essentially free of any credit risk."

but he skips past the correct answer, which is that the ratings agencies have
been suborned.

~~~
derrickpetzold
jellicle is correct the ratings are complete bs. If AAA actually meant
something the US would have been downgraded years ago. AAA means there is no
chance of default no whatever so ever. It should only be reserved for
countries with little or ideally no debt. The fact that our politicians and
media are openly talking about default means that AAA does apply to the US but
it does. So it means nothing.

~~~
RockyMcNuts
If a country has no debt, what security is being rated AAA?

~~~
wisty
OK, let's look at structural deficit, GDP growth, and Net International
Investment Position.

NIIP is interesting. Despite the US's huge debt, they have a reasonable NIIP
of about -25% (I think). So the money is mostly there. It's mostly in private
hands, but as long as the private sector is OK, the government will keep
collecting taxes.

The obvious problems with the US are its health system (more public funding
than countries with free health, but terrible value for money), its military
deployments (the military can be an OK if they use it to drive high-tech
growth, but actually deploying it very expensive), its prison system (they
tend to lock criminals up for a little too long, and they have way too much
crime for other reasons).

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JamisonM
The author argues that AAA debt is dangerous because it breeds complacency
because it is considered risk-free. It strikes me that this is begging the
question of how all these debt instruments can carry the same grade and do so
so consistently. Is it not the case that AAA debt is dangerous because most of
it is probably not really AAA?

I thought we established a long time ago that the ratings system is broken,
this is just another symptom of that illness that no one is willing to even
try to cure.

~~~
tptacek
That's his point. There is no conceivable way that even a large fraction of
that debt is AAA. What instead appears to be happening is a vicious circle:

* The finance industry engineers new ways to massage riskier debt into AAA products

* The market eagerly devours all the new AAA debt, building new business models and expanding previous ones based on the increased availability of risk-free products, thus

* Sparking demand for more AAA debt.

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rexf
An example of why not all AAA debt is truly AAA grade:

"As it turned out, triple-A-rated mortgage bonds stuffed with bad subprime
mortgages were considered very low risk" Source:
[http://www.nytimes.com/2011/07/10/magazine/sheila-bairs-
exit...](http://www.nytimes.com/2011/07/10/magazine/sheila-bairs-exit-
interview.html?partner=rss&emc=rss&pagewanted=all)

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phillmv
I wonder; is it not increasingly obvious that rating agencies are fraudulent
by nature/rent-seekers writ large?

~~~
tptacek
Maybe, but BRK and the US Treasury are meaningfully AAA. There is clearly a
class of AAA risk that means something, and a (far larger) lower tier of AAA
risk that merely rides the coattails.

~~~
Someone
The US Treasury is not, by definition, AAA. It can print money at will, but it
cannot guarantee that that money will have value.

~~~
uvdiv
Isn't all of its debt dollar-denominated?

edit: Now that I think about, it isn't. They have inflation-indexed bonds as
well. The more they print money, they bigger their debt grows!

[http://www.treasurydirect.gov/indiv/products/prod_tips_glanc...](http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm)

~~~
djcapelis
Yes, but which agency determines the rate of inflation? :)

~~~
mdda
At the end of the day, politicians could mandate that the government
statisticians lie about the inflation rate (make it artificially low to lower
CPI-index bonds payout rate).

But the currency markets would not be so easily fooled.

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jleader
Saying "AAA bonds will cause a crisis" is like saying "Homeowners' mortgages
caused the mortgage crisis". They're an essential part of the situation, but
the actual cause was the misrepresentation of the riskiness of the securities,
due to capture of the rating agencies by their customers, the securities
issuers.

Is there a term analogous to "regulatory capture", for capture of non-
government organizations like rating agencies by the subjects of their
ratings?

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ars
Yet another non logarithmic graph of money, sigh. When will people learn.

~~~
samstokes
This sounds like an interesting insight. Could you elaborate?

~~~
ars
Compare the difference between 1000 and 2000, vs 4000 and 8000. In both cases
it's double, but in the second case the difference appears to be 4 times as
large.

This graph is linear, so it makes it look like the jump from 4000 to 8000 is
more significant than the jump from 1000 to 2000, but actually it's not. It's
identical.

~~~
Andrew_Quentin
How is it identical? One has a difference of 1000 the other of 4000. We all
know that $4000 is much more than $1000.

The only thing they have in common is that both amounts have doubled, but I
think there is a huge difference between 1000 to 2000 with 1 million to 2
million although they both have only doubled.

~~~
ars
No, actually. With money the only thing that matters is the degree of change,
not the simple number.

The change from 1 million to 2 million is much more important than the change
from 99 million to 100 million.

Try an experiment: take a calculator or a spreadsheet. In one case start with
1000 then keep doubling it. In the other start with 1 million and keep adding
1 million.

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zipdog
If contracts and regulations require AAA-rated securities, then AAA-rated
securities will appear to match the demand.

As the author rightly points out: we have too many groups requiring AAA-rated
securities and not enough real AAA stuff to go around, so most of the AAA
ratings are going to be unreliable.

~~~
mtoddh
_If contracts and regulations require AAA-rated securities, then AAA-rated
securities will appear to match the demand._

I believe that this is what is happening, but the argument that demand for AAA
securities by overcautious investors is the root of the issue makes it sound
like all of our problems could have been avoided by curtailing the demand
itself- in this case, by encouraging investors to take on more risk (don't be
overcautious!) and be willing to purchase lower-quality securities.

As an investor, shouldn't I be able to choose what level of risk I'm willing
to accept? And isn't it the job of rating agencies to provide accurate
information so I that I can make an informed decision as to the level of risk
I'm taking?

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hollerith
If everyone switched from buying 6-month Treasuries to buying 3-month
Treasuries, debt issuance by the U.S. Treasury would double in one year, so
there is not enough information in the article to merit an "Oh no," but I
guess the OP had a deadline to meet.

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orofino
It isn't clear to me why AAA rated bonds represent such systemic risk, the
article says the following:

"They breed complacency and regulatory arbitrage, and they are a key
ingredient in the cause of all big crises, which is leverage."

Is the author arguing that these should all just be rated below AAA and as
such be accompanied with higher interest rates? This would obviously depress
the rate of issuance because companies would be less inclined to take the
terms (at least in theory). This makes sense to me, but doesn't necessarily
indicate that AAA rated bonds inherently have systemic risk as the author
states.

Perhaps I'll read the article a second time through.

~~~
tptacek
From the article:

 _Then look at the green line. Triple-A debt wasn’t a huge part of the bond
market back in the early 90s, but for the past decade it has invariably
accounted for somewhere between 50% and 60% of total global fixed income
issuance. That’s possibly the most horrifying bit of all: it simply defies
credulity for anybody to be asked to believe that more than half the bonds
issued in any given year are essentially free of any credit risk._

That seems like the nut. It's _prima facie_ obvious that much of what is
called AAA can't be AAA; it almost mathematically beggars the definition of
AAA.

Meanwhile, all kinds of contracts, regulations, and instruments rely on AAA
ratings to prevent money that can't reasonably be put at risk from going into
e.g. mortgage bonds.

~~~
orofino
Then I'm inclined to disagree at another portion of the post which seems
somewhat contradictory to the point:

"it wasn’t an excess of greed and speculation which led to the financial
crisis, but rather an excess of overcaution"

The greed then exists in alternate areas of the system. It isn't AAA bonds
that are the issue, it is the fact that lesser bonds are being rated as AAA.
Why are they being rated that way? The ratings companies have conflicts of
interest and were... (wait for it) greedy.

In addition, calling this an "excess of overcaution" is laughable, if I can
get decent returns from a "risk free" investment, that isn't cautious, it is
logical.

~~~
joe_the_user
Hmm,

I guess I agree but the thing is that "greed" and "over-caution" actually very
similar. Over-caution is greed for income without risk.

For example, Bernie Madoff's appeal wasn't based on offering income level that
no mutual fund could match but rather offering an apparent combination of
income and stability that no mutual fund could match (10%/year as reported
each quarter).

~~~
orofino
I think there are some differences, but regardless within the context of this
article the author states:

"it wasn’t an excess of greed ..., but rather an excess of overcaution"

I disagree with this statement, and clearly, based on your definition here,
this can't be true either. Unless, saying "is wasn't greed it was greed"
actually makes sense. Obviously I don't think you believe that, I'm just
pointing out a major issue with the article as a whole.

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njloof
Naked Capitalism weighs in on this article as well:

[http://www.nakedcapitalism.com/2011/07/felix-salmon-
misreads...](http://www.nakedcapitalism.com/2011/07/felix-salmon-misreads-aaa-
bond-demand-to-say-overcaution-caused-crisis.html)

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glhaynes
In what way do AAA-rated products "breed ... regulatory arbitrage." What does
that mean?

~~~
rgraham
See tptacek on this thread: <http://news.ycombinator.com/item?id=2768921>

A lot of regulation tells big often state-based institutional investors like
retirement plans and university funds that they have to invest X% in AAA rated
investments.

Demand for AAA rated products creates not just financial wizardry that spawns
more AAA products from riskier products, but the increasingly powerful finance
industry/lobbyists pressure government officials (usually appointed
representatives from the finance industry) to make this easier...if not
transparent.

------
BenoitEssiambre
This seems relevant: <http://www.youtube.com/watch?v=7GSXbgfKFWg>

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chopsueyar
It is either fear or greed.

------
shareme
Some items to keep in mind:

1\. War on Terror and TARP are large portion of the current USA deficit,
probably 80% or higher.

2\. Over-issuance of AAA ratings will come back to bite as it has to be
rolled-over at some point.

3\. TARP spending direct result of not controlling the security class known as
derivatives ...precedent last time we had to assert Federal control to correct
market excesses in securities as 1929-1930 with the SEC act. IN other words we
could force security exchanges to outlaw derivatives to bring order/stability
back but anyone receiving bank lobby money will not broach that subject.

~~~
kai-zer
False...

TARP is expect to cost the taxpayers, $25 billion. A small price to pay to
avert total financial ruin.

[http://cbo.gov/doc.cfm?index=11980&zzz=41404](http://cbo.gov/doc.cfm?index=11980&zzz=41404)

~~~
anonymoushn
If you give me a loan, then as it expires I take out a new loan to pay you
back, would you say that you've made money from the arrangement? I would say
that you haven't, as if I default the second loan you still take a net loss
across all our transactions. However in the case of TARP, many TARP loans were
rolled over into non-TARP loans, without the principal being returned at all.

We could also discuss whether it is a good idea to subsidize the losses of
some parts of the financial and automotive industries but not others, whether
this is really conducive to a healthy economy based on competition, and
whether the incentive structure created by handing bags of stolen money to
anyone who can credibly threaten to damage the economy is a good one, but this
probably isn't the place to do it.

