Clearly the rot is deep.

This reminds me of Simon Johnson’s article “The quiet coup” in the Atlantic a couple of years ago:

http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2009-1020-Johnson-article.pdf

As the months have passed, I feel the article has given a pretty reliable map

Erm, aren’t you getting a little confused here?

An “independent” ratings agency is one thing. A “publicly funded” one is another. How independent do you think ratings will be when they’re issued on the debt of the same people who pay the ratings analyst’s wages?

Isn’t that exactly the thing that is being complained about over the SP etc ratings of private sector bond offerings? That the people paying for the ratings shouldn’t be the people issuing the debt?

Now you could say that of course, a publicx agency would never lie to anyone at all. At which point you’ve got to explain hte Greek debt statistics of the past decade: they were fiddling everything all the way along.

BTW, you’re correct that SP etc don’t charge anyone for their sovereign ratings. Which leads to a further question: if we’re all getting something for free why are you so keen to start spending tax money on getting the same thing?

Tim @2: No. I’m not confused.

You’re making an assumption that I advocate the establishent of a European (publicly funded). I’m not. I’m interested in and open to whatever comes out of the House of Lords report, as is Chuka.

What I’m arguing here is quite specific. It’s that David Gauke’s arguments against the estalishment of such a CRA seem to be ignorant of the basic facts.

I agree there may be downsides to the establishment of a public CRA which are worthyy of investigation, but for you to argue that the current ‘big three’s” service is valuable simply because it’s free (though I suspect part of a wider system of corruption, which I hope the Lords will look into) ignores the fact that this “free” service may well be very damaging to real economies.

In the end, my argument is simply that the govt, represented by Gauke, has closed down parliamentary debate on the basis of utter ignorance of the fact about what a credit rating ‘market’ is, or in this case, isn’t.

btw Tim@2: I agree that ‘independent’ may not be as appropriate a term to define the propoised new CRA as ‘publicly-funded’, but then on course the same accusation could be levelled at the ‘independent’ OBR. You may or may not have offered this critique of the latter.

The idea that Chuka might be open to anything at all other than the advancement of his own career is slightly startling.

However, you’ve missed what Gaulke actually said:

“there is the danger that a public body would crowd out other credit rating agencies and reduce competition”

Public crowding out is not an unusual thought or concept. Boots Lending Libraries entirely disappeared when their publicly funded competition came into being. Crowding out is a big issue in macroeconomics.

It is possible that a publicly funded ratings agency would reduce competition in the medium to long term: as a result of that public funding for example it could (might, maybe) undercut the prices charged by the current incumbents and drive one or more out of business.

I don’t insist that this will happen of course, only that it’s possible and Gaulke is right to raise the point.

“is tantamount to saying that no public body is capable of governing itself.”

Yes, of course, I agree. As to the OBR I don’t think I’ve talked about it before but my general view is that it’s just as you say. Bit of deck chair rearranging, that’s ll. The politicians still call the shots.

Given the admitted failings of the Financial Services Authority and HMT to effectively regulate financial institutions and markets in the lead up to the financial crisis, which broke in the autumn of 2007 – any more for 120% loan-to-value mortgages? – we need to be duly cautious of implied claims about the supposed ethical or political superiority of public over private sector institutions.

Recall those reports of how successive government have lost billions of taxpayers’ money on failed computer contracts and the £30+ billion hole in the defence budget?

“The auditors for the EU have refused to sign off the bloc’s financial accounts – for the 13th year in a row. A report by the European Court of Auditors (ECA) criticises nearly every major area of the EU’s expenditure.” [2007]
http://news.bbc.co.uk/1/hi/world/europe/7092102.stm

The system of those who are being rated paying those doing the rating is not ideal, but the system of payment before the current one was even worse and full of conflicts of interest

One must remember those who complain about buying rubbish because a rating agency said it was triple A are lazy. Nobody forced them to buy the debt and no one prevented them doing some research and homework.

The whole idea of CRA for the sovereign debt of the main sovereign issuers is a bit of a nonsense and totally misleading. They are in effect not rating anything, they react with ratings to what ever has already happened in the capital markets. The market downgrades debt and the CRA react after the fact.

The Europeans want an ECRA because they believe they can manipulate them to say what they want them to say. Moreover, they are deluded if they believe the public market is going to pay any attention to the ratings of an ECRA if it is at variance with basic arithmetic. However, an ECRA would also be used as a form of disciplinary control of errant governments. Governments who did nor run with budgets pleasing to the EU would be threatened with downgrade by the ECRA.

Markets that under-price risk such as the euro periphery eventually correct. No amount of tinkering with CRA can change the basic debt dynamics.

Tim @5: I have to say the pointless ad hominem towards Chuka is a bit beneath your usual level of argument. I don’t think there can be much doubt, from the fact that he sought this adjournment debate in the first place, that he’s genuinely interested in this stuff. I’m not his PR man, but I think it’s good that’s he’s actually engaging in something without career-advancement headlines (I’d actually argue the same about the integrity of Bill Cash over his very unpopular views re: vulture funds).

Weirdly, I don’t think we’re that far apart on this. I agree that it’s fine for Daivd Chauke to raise a medium/long term possibility of crowding out (though I doubt whether CRAs are needed at all in anything like their current form), but he doesn;t do this; he simply says a European CRA is a bad idea because it reduces market competition, while not being clear about what the market actually is.

As for the wider question of whether governments can actually govern in the public interest (and what that public interest is), and your view that -within your classic lliberal parameters – it should all be left to the markets, well I think that’s a debate beyond the confines of a discussion about the specifics in my OP. However, should people wish to pursue it (I’m off out wth the kids when it stops pissing down), I’d simply ask – as a comparator – whether you think educational standards (e.g. degrees) should always simply be left to the market on questions of credibility, or whether you think there’s any validity in the idea that educational bodies can/should ge trusted to both provide university education and validate its quality in such a way that it maintains its credibility. I think peer trust, social capital and integrity go a long way, but I suspect you don’t.

@ Paul

Clearly neither you nor Chukku Ummuna really understand what and how the ratings work. I can’t say I’m hugely surprised.

The idea that ratings agencies are somehow “damaging” countries economies is pure and absolute rubbish. If anything, the ratings agencies are normally late to the party, as they change ratings on a purely reactionary basis. The fact that they put a “score” on their research is the only difference between their work and any half decent economic research from any other investment house or bank.

The long and short of it is that governments themselves are causing the damage to themselves by spending too much and running up too much debt. You dn’t need a rating agency to tell anyone that certain coutries are bankrupt – the CDS market gives a pretty clear indication of how credit worthy countries or corporates are, as it gives a clear market price for how much people are willing to buy default insurace for.

On that scale, the UK is more expensive to inusre against than McDonalds.

As for a European rating agency – it would hardly be independent, and any work it did would be roundly ignored, just like the European Bank stress tests conducted by the ECB. It would be a political entity, with massive self interest foist on it by European politicians.

“I think peer trust, social capital and integrity go a long way, but I suspect you don’t.”

No, I think those go a very long way indeed. Vastly further than anything cooked up by politicians or their handmaidens, bureaucrats. Which is why degree reputatons depend upon exactly those effects, what others think of the place you got your degree, not on whatever the Dept of Education thinks about it.

Which is rather why CRAs work to hte extent that they do. They have reputations to maintain in hte market, it’s not what governments say about them.

As to Chuka, man’s a grandstanding politician of the very worst sort.

He wants to remutualise Northern Rock because mutuals are cute and cuddly. He neglects to explain which part of public spending he’ll cut as a result of our not being able to sell it. He got completely cock-eyed over the Barclay’s tax bill, not realising that an international company will pay tax internationally, with other taxes being knocked off the UK tax bill, that companies that make losses can carry them forward and finally not noting that tax paid in a tax year does not equate to profits made in that tax year. Taxes are paid in arrears.

Didn’t stop him getting his name all over the papers though, did it? Oh, and he didn’t seem to know about SSE either. This from someone who agitated to get on hte Treasury Committee? He’s called for a windfall tax on the banks (eh? We want them to increase their capital so that they can continue to lend under the upscoming Basel III….more tax would mean a reduction in lending and back to recession!).

Man’s a knob and will do anything to get in the papers: a pure politician.

Blimey, he’s signed letters to The Guardian along with Richard Murphy and Prem Sikka. What else do you want as proof that he’s not fit to be walking the streets?

Genuine question: who rates the rating agencies?

I don’t see how a state rating agency could “crowd out” others unless there is some legal mandate that, for example, pension funds or banks must hold (some quantity of asset) of certain classes, as rated by this agency. i.e. if investors are forced by law to pay attention to them. Otherwise the only way S&P and others could suffer is if private investors decided this new rating agency’s rating were more credible, better quality, and hence worth paying attention to. Rather than being “crowding out” in a bad sense, that would be a good thing – a new entrant beating incumbents by virtue of being better than them. I don’t see the harm in a state backed agency so long as investors are free to pay no attention to them – what, however, are the odds that those behind the idea would also try to, say, tie their ratings to bank capital requirements and such like.

incidentally, I have half a memory that some banks and pension funds are obliged to pay attention to (existing) credit rating agency scores when it comes to asset allocations and such like. Is that the case? In which case that makes credit rating agencies not merely harmless providers of information that investors may or may not pay attention to, but something much more important and potentially dangerous.

This interview by Rortybomb with a former Moody’s director is worth reading.

The idea that ratings agencies are somehow “damaging” countries economies is pure and absolute rubbish.

No, they just don’t know what the hell is going on, and its unclear why anyoen should trust them after the financial crisis.

The idea that Chuka might be open to anything at all other than the advancement of his own career is slightly startling.

Its more startling to find you think you know what you’re talking about here.

Interestingly, Chuka is also in the Telegraph today with a comment piece on this:

“Policymakers must hold firm on reform of rating agencies”

http://www.telegraph.co.uk/finance/comment/8513457/Chuka-Umunna-Policymakers-must-hold-firm-on-reform-of-rating-agencies.html

Funny that when one of our top lawmakers wants to get involved in a serious debate about the future of the financial system, Tim Worstall tries to dismiss it as “career advancement” – wonder why that is. I welcome an ASI hatchet-job on this soon with a series of unfounded conclusions and poor research.

incidentally, the idea of forcing banks and others to hold government debt has been getting a lot of attention recently under the heading financial repression – one of the possible routes out of this mess

Luis, when are you going to start your own blog? I’m sure many of us would welcome it.

“Funny that when one of our top lawmakers wants to get involved in a serious debate about the future of the financial system, Tim Worstall tries to dismiss it as “career advancement” – wonder why that is. I welcome an ASI hatchet-job on this soon with a series of unfounded conclusions and poor research.”

You can find it already on my blog. Where I make the obvious point that Chuka starts off by whining about how nasty the CRAs are being to sovereign debt. And he then spends considerable time pointing to how part of the CRA problem is conflicts of interest. How debt issuers pay the CRAs and this leads to ratings that are, how shall we put this, less independent than they could or should be.

His solution is possibly a publicly backed CRA.

Only a small problem: the CRAs are not paid by anyone to rate sovereign debt. Thus Chuka is suggesting that unpaid and uninfluenced ratings should be replaced by ratings on government debt paid for by governments. In direct contravention of his own earlier finding that it’s issuers paying for ratings that causes the problems.

Yes, the man’s a tool.

And calling a noob MP, a whole year into his first term, one of our “top lawmakers” is really an arse lick too far Sunny.

No surprise to see Tim supporting the foxes police the hen house. Have you noticed how the business crooks are always allowed to police themselves?

The credit rating agencies in the US did such a good job of rating the sub prime credit defaults. (NOT) Of course it has nothing to do with the fact that the ratings agency’s relied on the big wall street banks who were selling this crap for their business.. Snigger.

@13 Sunny

As I said above, ratings agencies are backwards looking and reactionary to events. The CDS market is what people really look at to “rate” debt.

@15 Luis

Banks already (are forced to) hold massive amounts of government debt for capital adequacy/liquid asset requirements. It’s actually part of the PIGS problem though, as when this government debt goes sour the bank goes under….which we are about to see when banks are forced to take massive haircuts on supposedly safe government debt.

I do love the hypocricy of many on the left though when it comes to debt. On one hand they say that bondholders are evil, and should be forced to take any losses they incur if the bonds default….but on the other hand they want to keep massive deficit spending by the government, which requires people to buy the very same bonds.

Tyler @9:

You say: “The idea that ratings agencies are somehow “damaging” countries economies is pure and absolute rubbish.”

Researchers at the University of St Gallen, having employed complex regression techniques to establish the extent to which rating agencies’ rating of the PIGS countries are based on real world economic situations, and the extent to which they are simply ‘arbitrary’, say:

“The results suggest that rating agencies may indeed influence interest rates with rating markups that cannot be attributed to economic fundamentals. All estimates show that the rating markup for the PIGS countries during the crisis is significant and increases the credit spread for these countries.” (See http://www1.vwa.unisg.ch/RePEc/usg/econwp/EWP-1106.pdf)

Also my blog on this at http://thoughcowardsflinch.com/2011/04/05/credit-rating-agencies-and-the-fate-of-the-pigs/

Dispute the findings and the methodology if you wish (as is done by a commenter at my blog), but at least try to recognise that there are people with perfectly decent good track records who think CRAs are a part of the problem.

Tim @10: Forgot to mention before, but add for the record, that the German MEP who reported (or rapporteur-ed) to the EU Committee on Economic and Monetary Affairs was quite clear that he was not proposing a publicly funded European CRA (apart from a kick start lump sum):

“Your Rapporteur thinks that the possibility of establishing a fully independent non-public European Credit Rating Foundation (ECRaF) should be discussed. The financing needs of the new ECRaF should be estimated carefully and your Rapporteur suggests a one-off lump-sum payment to the foundation in order to ensure independence. This start-up financing should be enough for the first years of the new ECRaF, which shall be fully self-reliant after that period and finance itself in the market from rating fees. The new ECRaF would rate assets from all three sectors, public, companies and structured finance instruments and would hence have to be equipped” (http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//NONSGML+COMPARL+PE-454.361+01+DOC+PDF+V0//EN&language=EN)

This aspect appears to have been missed by David Gauke in his adjournment debate reply, where he suggests that a CRA would be fully publicly funded.

On the matter of education and slef-governance, my point is simply that universitues have degree awarding powers which we wield themselves in order to make a judgment on whether they have educated their students well enough. Logically, David Gauke’s reply suggests that this shouldn’t happen, because there’s a conflict of interest. The matter of universities’ ability to embed their reputation is a different matter.

Tyler @19:

You say “I do love the hypocricy of many on the left though when it comes to debt. On one hand they say that bondholders are evil, and should be forced to take any losses they incur if the bonds default….but on the other hand they want to keep massive deficit spending by the government, which requires people to buy the very same bonds.”

A handy caricature for the trollier comments pages perhaps, but no lefties here are saying bondholders are evil, as far as I can see, because we have a pretty good idea of who holds bonds and why (see Chris Dillow, for example:

“Today’s “rally against debt” should be called the campaign against the UK’s pension fund industry. What I mean is that government debt is not just a liability. It is also an asset, and a tremendously useful one.” (http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2011/05/against-the-rally-against-debt.html)

@ 20 Paul

I took the time to read that paper, and have to say was massively unimpressed. Ignoring that they’ve got some of their factual information wrong (OECD countries they use have gone bust since WW2), all they do is a simple linear regression. Anyone with a bloomberg terminal, excel and a little time can do it.

That in itself doesn’t make them wrong though. What does is that they turn around, limit the data series (to the 4 PIGS) then make the call that ratings lead credit spreads because 2 of the 4 pass a ChiX test to say as such (not that they say which two, but I’m guessing Portugal and Spain).

In real life of course, the other 2 of the 4 PIGS effectively went bankrupt and needed to be bailed out. The CDS market priced this in pretty quickly and the ratings agencies lagged behind.

Their paper is also pretty simplistic. They ignore a huge amount of information that the ratings agencies don’t – personal debt, mortgage debt, debt maturity profiles etc. Ireland, their example, was downgraded heavily after the Irish bank bailout, which effectively meant all the bank liabilities became government ones, and those liabilities were bigger than Irish GDP. But go ahead, if you beleive these guys you should be buying Irish debt as they think it should be AA rather BBB+.

Regardless, even if the ratings agencies didn’t exist, any proffessional investor will be getting soveriegn research from at least a dozen different banks who have large research departments, as well as numerous other sources. That research along with hte CDS market will give most people all the information they need to replicate roughly what the ratings agencies are saying well before they do. In a lot of ways the CRAs are a bit secondary to most proffessional investors – they are always late to the party.

@21 Paul

Never said you in particular, but you have many on this site alone who are arguing for more government spending, which would need to be funded by debt, whilst at the same time saying that bondholders in other situations should take losses and bank’s (massive bondholders) should be taxed even more etc. I just find the dichotomy of the logical view amusing.

Tyler

Sorry, long day away from computer yesterday.

Thanks for taking time to read the report. I agree that there may be flaws in the methodology – indeed the question is whether it is really possible to give any kind of definitive cause-effect answer through this kind of statistical analysis when there are so many variables. The critical realist in me says not, though the pragmatic bit of me says that this kind of quantiative analysis so dominates the social sciences to the exclusion of qualitative epistemologies that we may as well just live with it for now.

My point really was to suggest that there are two sides to the argument about cause-effect. If there weren’t, then the Portugeuse govt wouldn’t be bringing the criminal actions (of course you may want to shout ‘bias’ and ‘pre-determination’).

I do find it hard to believe that, where credit ratings are downgraded and austerity measures follow quickly (as happened in Spain last year) there is no cause-effect at play, associated perhaps less with the reality of the grading reasons (which may have their roots in the CDS moves) and more the impact upon political wills.

In any case, thanks for the engagement here – I think the wider readership will have evaporated on this post so I’ll do another one when I get chance on the specific question of “Do CRAs actually cause rate rises”, but more as a setting out of the alternative positions. Sure this question will come up again and again anyway.