The Shrine

What I don't get is who are these guys and why should we listen to them? Aren't they located in the USA so couldn't the government just seize their assets or whatever? I understand you want some kind of neutral party to decide these things but given those guys are totally off the mark during the subprime crisis, why is a bunch of guys allowed to just pass some rating that can basically ruin a country? If an evil supervillian took over one of those agencies like the plot of Gold & Silver could they rule the world by threatening to downgrading everyone's credit to junk status?

Japan's debt is at AA but they seem to get rates like an AAA nation. Is there any real substance behind these ratings or is it just another thing that stirs up fear and uncertainty? Well, of course there has to be some substance behind these agencies but is it wise for those guys to have that much power when history shows that they often have no clue how worthy someone's credit is?

With half our debt owed to ourselves and something like two trillion dollars sitting in our coffers they're being a bunch of fucking kids throwing tantrums. I can't see this having much of a long term effect by itself.

Long term wise US debt is almost certainly still one of the safest investment in the world, but there sure can be a lot of short term volatility, and I don't get why you'd even want anybody who doesn't exactly have a history of always right making these predictions. When all is said and done with economic theory a lot of stuff are still just wild educated guesses. Why is there a system like this that can have such a profound short term effect? Is it not enough that supply & demand exists? If US debt is a bad deal at current yield people should stop demanding it. I realize you can't always rely on the market so some benchmark wouldn't hurt but it's not like these rating are obtained by a formula (which still have a problem). They're basically a bunch of guys talk about it and decide on something, and these bunch of guys have proven to be quite wrong before. Not saying anybody else can do better but why put so much faith in a bunch of guys that may be no better than a coin flip? Shouldn't a rating agency just provide info like 'historically guys with this kind of capital and growth have a return of X-Y%' instead of having the ability to basically signal doom?

I don't get it, the republicans have what they want. Why is the economy in the shitter still?

They've basically gotten what they wanted in the economy for the last eleven years and it has clearly been SUPER EFFECTIVE :D

Shrinweck wrote:They've basically gotten what they wanted in the economy for the last eleven years and it has clearly been SUPER EFFECTIVE

It has, for the top 1%

Sure, but the rich, by definition, are doing fairly fantastic already.

Shrinweck wrote:They've basically gotten what they wanted in the economy for the last eleven years and it has clearly been SUPER EFFECTIVE

Your fellow voters sure seem to think that it hasn't been that effect, hence the change in Congress to assist the poor top 1% who are suffering so

It's just one of the three big rating agencies, the other two still have us as AAA. Also, credit ratings are just one factor out of many and the agencies have been largely discredited. However, the psychological impact of this is huge and is sure to have negative financial consequences.

It is worth noting that S&P's main reason for the downgrade is the GOP's complete rejection of raising taxes as a way to pay down the debt.

Zeus wrote:

Shrinweck wrote:They've basically gotten what they wanted in the economy for the last eleven years and it has clearly been SUPER EFFECTIVE :D

Your fellow voters sure seem to think that it hasn't been that effect, hence the change in Congress to assist the poor top 1% who are suffering so

If people voted with their wallets as much as they think then democrats would have been in control of office for the past decade. Republican politicians manipulating people into voting 'with their hearts' is one of the greatest tricks pulled off in the history of mankind.

sigh

NPR's Planet Money had an excellent podcast last week titled, Would a downgrade matter? that addresses these points. In fact, the Planet Money podcast is always excellent, and I recommend that everyone listen to it.

Theory breaks down when you've a market that seems to be dominated by fear. There's probably no significant long term effect but you can definitely lose your shirt in the short term. Right now I think people are just looking for any reason to sell. It's hard to say how much of the drop was due to downgrade alone (if it didn't happen people would still be likely to panic over something else) but it was obviously a very good excuse to sell.

When I was reading Gold & Silver the plot is basically this guy who funds the prime minister of Japan's campaign in exchange for having monopoly over the rating agencies and then just threaten to downgrade everyone to junk status unless they pay up. At first I thought that was a ridiculous plot but now I'm not so sure. Looking at what happened at today's stock market I can certainly see one of the big 3 agencies blackmail a weak country with a threat of a downgrade. I think they need to remove the big 3 from the Nationally Certified Whatever status they're currently on, since we're giving them some kind of nationally backed prestiege even though the rating agencies have successfully argued that they can't be held accountable for totally missing the boat because it's just their opinion. Well if it's just their opinion it should definitely not be backed by the nation.

Kupek wrote:NPR's Planet Money had an excellent podcast last week titled, Would a downgrade matter? that addresses these points. In fact, the Planet Money podcast is always excellent, and I recommend that everyone listen to it.

I like that and Marketplace with Kai Ryssdal. Listen everyday on the way home from work.

Kupek wrote:NPR's Planet Money had an excellent podcast last week titled, Would a downgrade matter? that addresses these points. In fact, the Planet Money podcast is always excellent, and I recommend that everyone listen to it.

Yeah, after listening, that's the same feeling I was having. If it was a big deal then people would be making a bigger deal about it. The talk about falling from investment grade was interesting and I had no idea Greece had fallen from it.

Well, would you invest in Greece? I mean, they're defaulting, so...

Don, as for all the harm someone could do if they got into the wrong position and then started being maniacal... well, yeah. The safeguards are mostly bureaucratic. And as soon as people realized what was going on, the ratings would fail to hold any weight. But, as you pointed out, outright malice is not the biggest danger with the rating agencies. It's systematic reversal of incentives - where the rating agencies are incentivized to give entities better ratings because of conflict of interest.

This is the second time I will go to bed and the Dow futures are off by over 200 points already. Who wants to bet that the Dow closes below 10000 by the end of this week?

There's a quote that goes like "Never assume malice when incompetence suffices." It could very well be that the major rating agencies thought all those financial contrapation are in fact rock solid investments (though they obviously have an incentive to rate them as trustworthy). I'm just bothered that they wield so much power even though their decision seems to be merely just 'educated guess'. Sure they're probably the best educated guess money can buy, but you can lose your shirt from best advice money can buy very easily. It'd be like determining whether a game is successful solely from 3 review sites without even questioning if these reviews may be biased/flawed/whatever.

Out of curiosity is it some kind of joke that that podcast gets added into my iTunes under the genre "Blues"? heh

Related, but off topic: I looked up this company's ratings of other countries. I noticed that the top countries are France, Germany, Denmark, Norway, Canada, and Sweden... These countries are the most highly socialist nations in the first world.

One also doesn't associate them with massive growth, but certainly stability. Oh what I'd do for some stability. Remember when we (I use we very, very loosely here) cared about what dog the Obama family was getting? Can't it be that way for, like, a week?

http://en.wikipedia.org/wiki/Hanlon's_razor

Never attribute to malice that which is adequately explained by stupidity.

The problem with the rating agencies and morgate-backed-securities was in fact systematic. It wasn't malice, but a combination of incompetence (few people actually understood both the complex bond structures and the implicit assumptions in them) and incentives (I believe they were paid to rate securities by the same companies that made them).

There's also a serious problem that is shared with all of the government regulatory agencies: the people they are regulating are smarter and more experienced. Basically, working for the SEC or one of the rating agencies doesn't pay well compared to the investment banks. Sure, you can probably earn a good upper-middle-class salary that is great compared to 90% of the country. But the investment banks pay embarrassing salaries and bonuses to their employees. So, lets's say you actually understand all of these complicated financial products. Will you work for the SEC or a rating agency for maybe 80-130k a year, or will you work for an investment bank where your salary alone will be 250k a year, and you can earn a bonus that is more than your base salary? That, I think, is a deep, systematic problem that I see no solution to.

The guy who wrote the laws does not need to be the most knowledgeable expert on laws in the world. The president of the United States is most definitely not the smartest guy in the United States. The problem is that a lot of these regulatory agencies are intertwained with the guys they're supposed to regulate. FAA and airlines is another good example. You don't have to be smarter than the guys you're regulating to regulate them, but you definitely can't be receiving money from them. It's true some of the financial stuff during the subprime crisis is very complicated, but I believe they say their model doesn't even assume housing will ever come down in price. You don't have to be a super genius to question whether a model that assumes housing price always goes up makes sense.

Don, that's just not true in the financial industry. If you don't understand what you're supposed to regulate, you can't regulate it.

I'm about to finish up No One Would Listen by Harry Markopolos. Back in '99, he knew it seconds - literally, seconds - that Madoff was not legit. The only question at the time was if his profits were real but he was abusing insider information (specifically, many figured he was front running), or if he was operating an outright Ponzi scheme. Now, of course, we know the answer. But Markopolos provided detailed documents to the SEC three times over nine years explaining all of the red flags with Madoff. The regulators at the SEC were simply not competent enough to understand Markopolos' stated reasons. Institution inertia and petty bureaucratic turf-wars were also part of it, but fundamentally, they did not understand it.

That the regulators - both in the government and in industry, such as those at the rating agencies - are simply not as nearly as competent as the people they are supposed to regulate is a theme I have read over and over in multiple books: Too Big to Fail, The Big Short, The Quants and The Sellout.

By your logic if I am the world's undisputed leader in some field of economics/finacial market (and ahead of the #2 by a decent margin) then nobody would ever be able to tell I'm running a scam. This just can't be true. Let's say I start up a hedge fund and my stock choices are based on whatever manga I thought was good this week, and due to some freak stroke of luck this ends up making me a ton of money. I tell you it's a process called the Wangsian model and clearly nobody on the world besides myself would be qualified to understand why this model works. But if you suspect I'm really running a Ponzi scheme then there's got to be some people not getting any money back from joining my fund (or it wouldn't be a very successful Ponzi scheme).

The original Ponzi scheme isn't even very complicated. It was readily obvious with some math that there's no way it could've worked, but that didn't stop people from believing it could go on forever. I think the problem you have here is that supposed I am running the Wangsian model today and it's really a scam, if you're just a regular guy you would probably be hesistant to call me who is probably now a legend on Wall Street as a fraud. Besides, I'm sure people have said Warren Buffet is a fraud (we'll assume Warren Buffet is legit). But if I'm running a Ponzi scam the money has to be disappearing to somewhere, and of course I can be clever and try to hide it, but ultimately there has to be some money missing in the system because otherwise my scam would have failed.

During the subprime crisis, the impossibly complicated derivatives are obviously based on models and language far beyond our comprehension. However these models assume that housing growth will pretty much continue forever at its super high pace, and don't even attempt to hide it. Again you don't have to understand how all those derivatives work to ask the question: "What if housing growth slows down/stops/declines?" Quite a few guys asked that question, so it's not like coming to this conclusion requires understanding how the impossibly complicated system works. Now those guys are obviously ignored probably because people prefer to listen to the guys who are super rich saying of course growth can continue forever because everyone needs a house. No doubt all the factors mentioned can help suppress the guy who's saying the emperor has no cloth. But to realize that there's no fundamental law that says housing must grow forever does not take any world class understanding of the system.

I don't know how you'd actually regulate it, since if you raised the issue about say housing during the housing bubble people will most likely just say 'our super smart guys all say this is the way it's been since the beginning of time, what does a bum like you know?' and you'd obviously have a hard time getting your voice heard. But I think this is an issue of people falling prey to 'get rich quick' ideas that's been around since the beginning of history. I don't know if it'd have been possible to diffuse the subprime crisis, but you definitely don't need to be super smart to say that some of the models used at that time may be fundamentally flawed.

No. I'm arguing that the regulators often don't have a base level of competency. Unlike other areas, the base level of competency is actually a high bar. And that those that do acquire that base level of competency can make far more money on the investment banking side, and often switch sides as soon as they can.

But if you suspect I'm really running a Ponzi scheme then there's got to be some people not getting any money back from joining my fund (or it wouldn't be a very successful Ponzi scheme).

That's not true until your Ponzi scheme falls apart. And at that point, "regulation" does not do you any good - once a Ponzi scheme falls apart, it's obvious to everyone what happened. It's purely a criminal matter, then. The point of regulation is to detect a Ponzi scheme before it falls apart. Madoff went 20 years before he reached that point, and that was only because of the financial crisis in 2008. If the financial crisis had not happened, it's quite likely he would have been able to continue to bring in more people - he had already brought in $75 billion.

By the way, what you described is basically what Madoff did, and he did it for almost 20 years. The SEC was not competent enough to do the basic checks to make sure he was doing what he said he was doing - because they didn't actually understand what he said he was doing. Markopolos actually submitted evidence to the SEC five times in nine years. I'm now at the part of the book where he talks about the reforms the SEC is making, but only time will tell if they make a difference.

There were people who thought that mortgage-backed securities were fundamentally flawed. But there were very few of them, and even fewer who were confident enough in their analysis to stake their careers on it - read The Big Short for some people who saw it coming and bet against it, big. It's easy to say now that " you definitely don't need to be super smart to say that some of the models used at that time may be fundamentally flawed" because you have the perspective of hindsight. You know they were fundamentally flawed because they blew up. Understanding how everything worked as it happens is very different. The reasons why the mortgage-backed securities blew up are fundamentally simple. But to be confident that those simple reasons would bring down the house of cards required being able to understand why all of these people giving complicated answers are wrong. Most people weren't confident enough in their knowledge to do that.

If you can have a Ponzi scheme that's mostly undetected then it sounds like it's indistinguishable from just keep on borrowing low interest loans to pay for whatever you owe back when credit was easily available and worry about the problem later (not unlike what the USA is accused of doing). With credit as cheap as it was during the subprime crisis there's obviously a lot of ways you can exploit the system. That's why credit is not supposed to be that cheap for extended period of time and I don't think it's fair to blame it on the regulators. The Feds should never have left the credits so low for so long. The risks for having such low interest rate on credit is very well known.

For the derivatives, there are multiple articles documenting that they're modeled with the assumption that the housing growth never slows down. Sure none of us is qualified to say "Therefore those derivatives will collapse", but you can say that there is something wrong with the assumption that housing growth never slows down. It's quite possible that no one really knows what happens to these model if the growth of housing slows down. Financial market is a matter of risk and return, so it would be sufficient to say that because the model doesn't account for things like housing boom slowing down then it is a risky investment so there's no way it should get a rating equal to US soverign debt.

When you see one of those 'get rich quick' ads that show up on TV or even most websites, you don't necessarily know why it doesn't work since whoever came up with that is probably more knowledgeable than you at least in the particular field he is advertising, but this doesn't mean you should fall for these every time you see one because you can reasonably assume that there must be some kind of elevated risk for those returns. The derivatives are very tough to figure out how they interact but I think it was obvious there was no way you can say those derivatives have practically no risk (AAA) because the housing boom cannot continue forever.

The entire problem with this nations economy and debt crisis is people have not been thinking about long term solutions. Businesses and the markets are more worried about the quarter than the 5 to 10 year span and as Don said, the market was assuming that housing could go no where but up. They obviously assumed wrong because of the de-regulation of the mortgage industry and predatory lending practices by some of these banks.

Don wrote:If you can have a Ponzi scheme that's mostly undetected then it sounds like it's indistinguishable from just keep on borrowing low interest loans to pay for whatever you owe back when credit was easily available and worry about the problem later (not unlike what the USA is accused of doing). With credit as cheap as it was during the subprime crisis there's obviously a lot of ways you can exploit the system. That's why credit is not supposed to be that cheap for extended period of time and I don't think it's fair to blame it on the regulators. The Feds should never have left the credits so low for so long. The risks for having such low interest rate on credit is very well known.

Except that's not what he did: he continually got new "investors." He did not take out loans for his returns. He pulled more money into his scheme. For 20 years. It is the regulator's fault for not catching that. His scheme was not enabled by subprime loans - he started it well before that madness. Rather, the subprime implosion is what brought his scheme tumbling down: when the rest of the economy takes a huge down-turn, it's going to get harder and harder to pull in more investors. And the moment a Ponzi scheme can't pull in more investors, it falls apart.

Madoff told investors what his investment strategy was. He produced - fake - documentation about the trades he made. He posted consistent returns every month that had zero correlation with the rest of the market. These are all things that Markopolos and others noticed. In fact, that Madoff was doing something wrong was an open-secret among some of the investment bankers. They knew something was wrong with his numbers and explanations, so they kept their money away from him. (Few thought he was running an outright scam; they figured he was front-running and using money borrowed from his legit operations to achieve the consistent returns.) But the regulators weren't savvy enough to see it, even when presented with the evidence.

Obviously you can't possibly catch every crook out there. If you're careful enough you can certainly lie and fake your way for a pretty long time. I don't see how that the competency of the people matters, because if you can find enough people to invest in a Ponzi scam then it takes a while until you run out of the bottom of the pyramid. Given credit was super cheap and interest rates were nonexistent at that time, it was clearly pretty easy to find new investors and until the bottom falls out I don't think you can say for sure the difference between a Ponzi scheme or just someone who happened to be super lucky or a super genius.

Take something I've been following, SpaceX. No it's not a financial system but it's not that different. SpaceX claims they can launch rockets at prices way below anyone else can possibly do. First of all it is entirely possible that they're totally legitmate guys who found a way to build rockets better than anyone else, so you can't just flat out say since nobody's ever done it before it has to be fake. There's a pretty good chance that those guys do have a revolutionary way/model/whatever of doing business. Now suppose this stuff is just fake, but even if you're the #1 authority on rockets in world I can still say we came up with a new way that's better than what you know, and I can certainly fake reports to back up my claim. It'd be impossible to prove what I say is false until I actually tried to launch a rocket. That said if you've to give a rating for the trustworthiness of SpaceX I really don't see how you can say they're an equivalent of AAA, i.e. nothing can possibly go wrong. The more expertise you have in the field the more accurate assessment you can make on the real risk, but even someone with a rudimentary knowledge of rockets should be able to say there's no way SpaceX can have an AAA rating (i.e. practically no chance of failure).

I think the AAA rating is almost like the grade inflation and it just means 'passing' in school. We obviously can't expect rating agencies to be prescient so it'd be completely unrealistic to assume they can always get the rating exactly right, but that doesn't mean they should tell you nothing can possibly go wrong on something that can clearly go wrong. If they want to say Madoff's equivalent of an A instead of B++ or whatever the notation is, that's fine. But it is not an AAA.

Just read about it instead of guessing. Madoff was the largest "hedge fund" in the world. (I use quotes because he wasn't actually a hedge fund, but that's what he presented himself as.) He had $65 billion (with a B) invested before everything collapsed - that's about 10 times larger than the number two spot hedge fund. If you can't catch him, even after being told five times with excruciating detail exactly what to look for, then you are incompetent at regulating securities.

I don't think you can say for sure the difference between a Ponzi scheme or just someone who happened to be super lucky or a super genius

You can, actually. No one is that smart or that lucky - Madoff posted three down months in almost 20 years. His returns had no correlation with his stated strategy. That kind of evidence allows you to say that his results were "impossible" - technically it's possible, but the likelihood is so low that we just call it impossible. See, for example, the second law of thermodynamics. But that's just looking from the outside. Had the SEC been competent, they could have proved he was a scam in seconds: compare his stated trades against the official records. They did not match. But the SEC did not do this.

By the way, after all of this went down, the newly appointed Inspector General of the SEC did his own investigation into the SEC itself, including an extensive interview with Markopolos. I'm just relaying to you the same conclusion both men came to. The SEC has been reformed based on this very high profile clusterfuck, for the reasons I've mentioned. Time will tell if it was enough.

Anyway, I don't know what your last paragraph means - you're mixing the Madoff discussion with the rating agencies, and they don't have much to do with each other. Madoff presented himself as a hedge fund, which don't get ratings. Hedge funds invest their money in various bonds and securities that have ratings. And AAA is not "passing." The "passing" threshold is between BBB- and BB+; BBB- is the lowest "investment grade" rating.