Today’s Fin runs a letter from Standard & Poors responding to my column from last week, reprinted here. Unfortunately the letter is paywalled (if anyone would like to email me the text, I’ll make fair use of it), so you’ll just have to take my word that it contains some interesting semantics. For example, the writer takes umbrage at the suggestion that S&P “threatens” governments with the loss of AAA credit ratings, but does not deny that the agency explains to government that certain policies will lead to the preservation of the rating while others will not. (“Nice little state you’ve got here …”)
I’m most interested though, in a claim that, since 1978, the default rate on AAA-rated structured finance offerings has been only 0.5 per cent. Obviously, a statistic like this can mean just about anything, but the claim is surprising to me. AFAIK, the biggest single category of structured finance offerings rated AAA by the agencies were collateralised debt obligations (CDOs) and the vast bulk of these were issued in the last few years. According to Alan Kohler in today’s Business Spectator (I think the ultimate source for this is Gillian Tett in the FT).
Between 2005 and 2007, about $US450 billion of CDOs of asset backed securities were issued. Of those, $US305 billion are in a formal state of default, with those underwritten by Merrill Lynch accounting for the largest proportion, followed by UBS and Citigroup.
The real problem is what has happened after the default. JPMorgan estimates that $US102 billion of the CDOs have been liquidated; the average recovery rate for the super senior tranches – rated AAA – has been 32 per cent. For the ‘mezzanine’ tranches – created from mortgage-backed bonds – the recovery rate is just 5 per cent.
Up to a 95 per cent real loss rate on AAA debt CDOs …
(Note that, although the text is ambiguous, the top mezzanine tranches were typically AAA-rated – the super-senior stuff was supposed to be better than plain old AAA).
The default rate here is over 60 per cent, which is a bit higher than 0.5 per cent, and it’s safe to bet there are more defaults to come. Even assuming that older issues pull the average down, can there really have been anywhere near $60 trillion ($300 billion/0.005) of them issued, as you would need to get the S&P average default rate? Or is this the kind of average that conceals more than it reveals?
Update A kind reader has supplied me with the text, and I’ve selected the relevant bits for reference (OTF). If anyone is still interested, and keen to do an Intertubes meme mashup, we could do a crowdsourced fisking.
In “Risky business needs rethink” (Opinion, February 26) John Quiggin evaluates Standard & Poor’s February 20 downgrade of the state of Queensland to AA+ and in the process misstates the role of a credit rating agency and how credit ratings should be used.
Standard & Poor’s does not “threaten” states or other rated issuers with downgrades or make demands to “implement whatever economically irrational policies”. Nor do we act as an “advisor to bondholders” or “ensure that bondholders get paid in full and on time”.
Our sole role is to provide the market with an independent opinion on the creditworthiness of issuers and their debt. A Standard & Poor’s rating does not speak to the market value of a security, or the volatility of its price. Ratings are not recommendations to buy, sell or hold a particular security. Nor do they replace the need for investors to do their own risk analysis or to seek professional advice.
…
Like many others in the market, we did not anticipate the speed or extent of deterioration in the US housing market. However, our track record remains strong. Since 1978, only 0.5 per cent of AAA structured finance ratings have ever defaulted, which is broadly similar to corporate ratings performance.….
For many decades, Standard & Poor’s has in effect served the global capital markets with high quality, independent, and transparent credit ratings. We have listened to what the market is saying, and reflected long and hard on the recent, unprecedented market events. We are working with market participants and policymakers worldwide to do our part to restore confidence in global financial markets.
John Quiggin 
Meanwhile in todays SMH, Anne Davies article, “Insurers playing in hedge enrage a prudent economist”,
reports that non other than Ben Bernanke conplains that:
“AIG… acted like a hedge fund, not an insurance company, costing shareholders then taxpayers billions…
Under-fire Bernanke said that,
“… nothing had made him more angry during the months of the financial crisis than the episode wth AIG”, noting that:
” AIG exploited a huge gap in the regulatory system. There was no oversight of its financial products division. This a hedge fund… attached to a large and stable insurance company”.
Another triumph for self regulation, narcissist-style or do we just blame government for lack of legislative and enforcement imagination and resources during the up-cycle, when looking sideways at a company like this would have heard screams of infamy echoing to the rafters.
And how often, all over the world, did incidents like this happen during the last decade?
What was the story with AMP/Westpac, if I remember correctly?
Oh come on Professor, from what I read at Cato, the CIS and IPA it was all due to “government failure”, the CRA, Fannie and Freddie, and the now disowned champion of Laissez-faire, “Easy Al”.
Paul, we have banks and insurance companies with these hidden arms “the hedge fund casino arm” of the company.Bernanke apparently fumed about it (They found a loophole in the regulation and exploited it etc. This is not much better than a casino firm having a hidden off shore banking arm is? Would you bank there? Only if you are a gambler. Well the fabric of regulation does have loopholes as Bernanke notes. A bit like Sydney shark nets.
And of course, as carbonsink well notes, according to the CIS,IPA – the GFC is all now the governments fault. They do have a point. The government allowed itself to be bullied by the top hatted lunch chums and their rant machines into removing that “terrible” burden to business -the despised R word. Score – one to the top hatted lunch chums, none to Government, and minus one to the rest of us. De-regulation means making holes they can drive a Bugatti Veyron 16.4 through with a trunk full of the now ailing and bloodless company’s cash.
“All this does is send a signal not about the true credit rating of the state governments but rather the seriousness of their financial management” – SeanG @ 30
But Sean, that is explicitly what the S&P letter argues they do NOT do. Their claim in that letter is that all they are doing is assessing the likelihood of default, and the rest is none of their business.
And as you point out, the likelihood of Qld defaulting is utterly negligible. John’s point – that far from being impartial judges of risk they have a strong bias towards their ideologically sound friends – is spot on.
Clearly Standard and Poors are feeling the heat otherwise why would you comment and why would share prices of rating agencies be falling. Not only is the market questioning their ratings, they are questioning the long term existence of rating agencies.
I go back to the Victorian experience, the rating was reduced, the rating was restored by moving a few assets from debt financing to equity financing. It was good for the state ( the sold the stuff at pretty good prices) but from a risk point of view did things really change. Less assets backing less debt, big deal.
Also, any rating agency that downgrades Australian state debt and not Australian federal debt has very little understanding of Australian politics. As debt risk has a lot to do with political risk this too shows a complete failure to deliver the supposed service.
To Eli’s point; a low default rate over a period where all debt showed a low default rate proves absolutely nothing. The interesting statistic will be the default rate when the asset class is under stress. 2008 and 2009 are the years of interest.
And talk about a conflict of interest. The regulatory requirement that some institutions only invest in debt rated at AAA by these clowns would be for the clowns to downgrade the rating on US government debt.
Eli Says: March 4th, 2009 at 9:12 pm
Of course there is absolutely nothing wrong with S&P credit rating agencies. For almost a decade the Big Banks have been indulging in kleptocratic shenanigans. Which is why S&P gave them all CCC ratings from the early noughties on.
We all remember over the same period the S&P index correctly predicted that industrial earnings growth would flatten out in the noughties. Given the internet is a money-pit, corporate financial accountability standards had dropped faster than a whores knickers during shore leave and Bush was a spend-thrift addicted to “Debtiquity and Diversity” delusions.
Oh wait a minute, that “sound financial advice” all happened in a Bizzarro parallel universe. Back in our universe S&P hot-shots swallowed the Greenspan and Bush Kool-Aid with gusto. Which is why one-time gilt-edeged securities are now junk and the S&P index has a distinctly retro feel. I love the droll aside from Wikipedia:
So things are great until they are not. For this we pay these guys a fortune!
Eli seems like a fair and reasonable person. But I wonder if he has any idea of how much the financier profession (for which he offers sophisticated apologetics) is loathed in the general community. The hostile public reaction to the first Bail Out offer was phenomenal.
The financial class has always had a high ratio of swindlers, spivs and shysters combining the worst aspects of parasites and predators. Nowadays they get rich quicker by creating churn, generating frenzied turn-over whether it be through volatility (“traders meat”) or momentum (“follow the money”).
The financial industry creates very little wealth. It merely “unlocks wealth” ie takes it off the productive class – workers, technicians and pforessional-managerial – and doles it out to insiders, fast-buck merchants and straight-out embezzlers. Before the GFC hit I described this as a “rolling white collar crime wave”.
But dont take my word for it. Ask the experts. Warren Buffet is not too impressed with the post-modern financial industries efforts. Way back in 1999 he was expressing skepticismabout the advice offered by the Exchanges little “helpers”:
In the aftermath of the dot.com bubble he wrly observed that the avante-garde of finance is now “designed more with an eye to making money off investors rather than for them”.
I suggest that its time to follow the example of a well-regarded Middle Eastern tradesman and chase the money lenders out of the industrial temple. For most of this decade I have fantasised about a (humane institutional) “purge” of the financier class. Right now the organic workings of bubble-busting capitalism perform this function – but only until the Next Big Thing comes along.
It would be nice if we did not have to experience GFC Groundhog at the end of every decade. It would be in the interests of everyone if members of the financial class underwent a little bit of Maoist-style self-criticism and self-correction in wash-up from their latest fiasco. If only to forestall more distasteful options later down the track. I’m thinking “proceeds of crime” legislation, Tobin taxes, things like that.
My comment at 56 should have read
And talk about a conflict of interest. The fastest way to get rid of the regulatory requirement that some institutions only invest in debt rated at AAA by these clowns would be for the clowns to downgrade the rating on US government debt, yet the only thing saving the clowns is the regulatory requirement that debt is rated by them.
Paul@31
I agree with the sentiments that there has been a huge amount of negligence with regard to the financial system, not only on behalf of the ratings agencies but also financial institutions, investors, government, central banks and borrowers. To label the entire finance industry as producing nothing is ridiculous. Without a well functioning financial system, you could expect living standards to drop. Take Alice as a case in point, she makes a deal about paying off her mortgage without seeming to realise it was through finance that she was able to purchase the house in the first place.
# 59 sdfc Says: March 5th, 2009 at 1:21 pm
I was careful to strew my inflammatory comment with qualifiers – “nowadays”, “post-modern”, “from the early noughties onwards”, “avante-garde”, “For most of this decade” et al. But apparently no amount of qualification can forestall the hasty construction and clumsy demolition of a straw-man.
In fact I would give my back teeth – cavities and all – for a “well functioning financial system”. But that is exactly what we aint got since contemporary finance became post-modern in its methods whilst re-doubling its Mammon worship.
FTR, and in deference to the delicate sensibilities of all honest-to-goodness financiers within pixel shot, I hereby proclaim that the vast majority of routine, boring, High Street financial transactions are doing yeomens work. And Wall Street types were, until the early eighties, generally well-behaved under the heavy-handed thumb of the SEC.
But things have gotten out of hand in the Big End of Town in the post-financial deregulation era. Especially since the lure of the carry trade dangled carrots all over the shop.
The OECD has experienced a massive increase in the frequency of financial transactions, scale of financial industry and remuneration of financiers since the mid-eighties. Without seeing anything like a corresponding increase in general industrial productivity. Money for nothing!
According to Business Week the US has just experienced the economic “Failure of the Internet Decade”. Mostly pissed up against the wall by people getting carried away with trading and spending rather than producing and investing.
But financiers get away with it in broad daylight even though (or because) as Kinsley once remarked, “the scandal is what is legal”.
The case of the CRA’s is only special in the context of finance in general. Mainly in the sense that these agencies are supposed to be, like Roman matrons, endowed with virtue beyond reproach. Yet they have behaved like complete harlots selling themselves to the highest bidder.
The same sort of financial arms race logic seems to have applied to Executive Remuneration Committees, Big Four auditors. Who pays for all this largess is the long-suffering investor/saver. Not to mention the general industrial system which now suffers from a version of financial Tourettes syndrome in sympathy with the gyrations of the money-movers.
True to corporatist-strategic management and media management, S&P makes it public that it is in favour of changes in regulation of the rating industry as long as there is “global cooperation between regulators to avoid the duplication of region-specific requirements that may arise between the U.S., Europe and Asiais” – ie so long as everybody else does what they say and believes ‘the message’ that it is not S&P who has anything to do with the current mess.
http://online.wsj.com/article/SB123617143365428791.html?mod=googlenews_wsj
But there is an alternative market oriented approach which doesn’t require rating agencies at all.
Rating agencies make a living from substituting debt for equity and corporations have an incentive to substitute debt for equity because the rate of return (interest) on debt is tax deductible but that on equity (dividends) is not. In the US, there is an additional incentive; dividends are taxed twice – at the corporate and at the personal level. Note S&P are not interested in promoting dividend imputation. Note, S&P does not advocate making interest payments not tax deductible.
Any security which, at the time of issue, has a positive probability of default for a predetermined positive rate of return in the foreseeable future has the payoff profile of equity and not debt (if it walks like a duck and looks like a duck, it is a duck and not a goose.) Note, S&P does not provide public advice on the appropriate classification of securities as debt or equity, instead it charges fees to rank mis-classified securities into risk categories, of which those named in JQ’s article are the most obvious ones. During earlier times there were ‘junk bonds’ and unless the incentive to substitute of debt for equity is removed, the next bubble will come togeter with new alphabet-soup labels.
There is no need for ranking agencies to reclassify existing corporate debt because not only S&P can read balance sheets but a huge number of people in all countries can to that too and these people have additional local information which a global ‘player’, such as S&P hasn’t got.
For the small stuff – housing loans, car loans, small business loans, working-capital loans – banks and oter local financial intermediaries used to have quite adequate credit analysts. These people have local information and some degree of discretionary power which is taken away by a centralist rating agency such as S&P.
It is amusing to see how proponents of ‘free markets’ come to the defence of the centralist power of S&P.
Anyway, S&P’s strike to JQ’s article is a strike with a limp lettuce leaf.
Jack, it is nice to see you think my apologetics are sophisticated…
It is an interesting post. In narrow terms with regard to the rating agencies I should perhaps point out that whatever the banks’ shenanigans may have been, the rating agencies do not assess ethics. Just solvency. These concepts used to get conflated back in the 19th century but, now, no dice.
The real pity about the rating agencies is that there were once considered to be one of the very few places in the financial sector which have preserved its independence (of thinking and spirit) and have not been driven by money alone. The aristocrats of Wall Street they used to call Moody’s. Not any more.
And so the cynicism about the financial sector and bankers is understandable. That is not the same as denying that finance play a very important role in the modern economy. Jack says that it takes wealth off the productive class – workers, technicians and pforessional-managerial – and doles it out to insiders, fast-buck merchants and straight-out embezzlers. This is sort of unreconstructed left wing mumbo jumbo I have not come across for a while. Is not also true that finance play a role in allocating resources efficiently, from savers to users, as it were? And the problem we have is not with the concept but with a specific instnace of a debt-fuelled-bubble in finance we have seen over the last 20 years? And once the finance sector naturally comes back down to its fair share of the GDP, a better balance would be achieved? Which does not equate to a ‘purge’ of the financier class or moralistic posturing? Etc. etc.
sdfc#59
Quite. It does help to borrow money from banks for businesses, to pay of the home etc but little old me didnt plunge the loan into a hedge fund, that collapsed (or a multitude of other financial service operater that recklessly created a myriad of financial derivatives no one could understand), and then gambled on them.
Banks are useful. The distorted inner twistings of banks are not. They stepped well outside their core business, and in doing so brought themselves and their own businesses down. Banks should be run prudently. I dont decrie the financial sector, I decrie behaviours within the financial sector that have been ludicrously greedy and stupid.
There is only one real solution to any of this and that is to completely remove the influence that those of means have to influence government (and to penalise severely any organisation, politician or individual who attempts to impose its own view of regulation through the use of money or might) from the election process and local government upwards through through government at the highest levels. The second part of this is to reward well any person who is willing to perform public service in a political leadership role under these conditions.
There is no economic theory (liberalism, social democracy, free market theory)that will prevent or correct the problems that beset us now in the absence of the above and it is useless to even imagine there is.
Jack, I partly agree with your comment “I suggest that its time to follow the example of a well-regarded Middle Eastern tradesmanchase the money lenders out of the industrial temple”
But we first need to chase the financial scions and their temples out of the halls of government.
Jack Strocchi, send that post to the Fin Review. A brilliant rant. I’d put it on the front page. That’d fix their circulation crisis.
The finance tail was wagging the economy dog – no question.
# 62 Eli Says: March 5th, 2009 at 3:11 pm
I see straw man construction is the one part of the dwelling industry that is still booming. I specifically and repeatedly limited my condemnation of “finance” with various qualifiers (“nowadays” “post-modern”) meant to exclude old-fashioned, routine finance.
But I guess I did not take the precaution of acknowledging that yes, traditional payment-settling bankers and order-lodging brokers do perform a useful service. As opposed to their with-it comrades who leverage themselves to the hilt to play the stock market or industrial companies who engineer innovative financial instruments rather than gadgets. Will that do?
I find your talk of finances “fair share of GDP” intriguing and rather charming, in an “unreconstructed Left-wing” sort of way. However it smacks too much of “moralistic posturing” for me, hardened cynic that I am. The specific institutional response to the meltdown will vary with cases, but it will not be pretty.
We will see much tighter, more conservative prudential and political regulation of risky lending and borrowing behaviour. With no more blank cheques written to reckless investors. (Suddenly “ole green eyeshades” is meant to be Left-wing?)
There will probably be taxes levied on certain types of transaction. And whole instrument classes (such as the more esoteric derivatives) appear to be going West. Good riddance.
Also there is now a major asset/liability deflation in progress. The phony zeros will have to be purged out of the system. As will the unproductive spivs who put them there. I see that the financial industry in Manhattan is forecastig 180,000 job losses. Good. They can go out and earn an honest living like the rest of us.
This walks like a purge, it sounds like a purge. So I am going to call it a purge. (Which literally means: getting toxins out of the system.)
Eli says:
So, according to S&P one year ago, Iceland’s financial authorities may have been scoundrels but at least they managed to balance the books properly.
Has it occurred to you that institutionalised embezzling, apart from being unethical, is also poor business practice, at least for the long-suffering share-holder and tax-payers? (If my criticisms seem a little sharp please do not take it to heart. Blogs can get snarky sometimes, but we should remember follow Tom Hagen’s advice: “its business, not personal”.)
Eli says:
I find your political classification of me as an “unreconstructed left winger” is rather quaint and other-worldly, given the way the tables have turned recently. You are going to have to get more used to more of this kind of talk, coming from unlikely sources.
Have you not noticed that GW Bush, poster-boy for unregulated capitalism, recently nationalised the bigger half of the US banking system? This looks like “re-constructed Left-winger” to my admittedly dimly-focused eyes.
I am not the only one spouting “Left-wing…mumbo-jumbo”. (what part of “parasite” and “predator” dont you understand?) Buffet’s line about bubble financiers “making money off investors rather than for investors” could have been lifted straight out of the Communist Manifesto.
And remember those “weapons of financial mass destruction” that he warned of back in 2005? UNlike the Iraqi ones, these were actually found, werent they? Under a black hole marked CDO.
In short, the excesses of GFC have swelled the ranks of “unreconstructed left wingers” with some unlikely bed-fellows:
– right wing politician, worlds most x 1.
– billionaire businessman, worlds best x 1.
How the worm does turn!
* FTR I am a conservative social democrat, trying to curb my authoritarian urges.
My trouble with the suggestion that the GFc was in part due to the failure of the regulators is that the regulators are part of the gov’t sector and are therefore unlikely to be paid as well as the people they are supposed to be regulating. On this basis any of them who are any good would have moved to the private sector very quickly (unless there are still a few who believe in the worth of gov’t work for its own sake left). This would leave the dross behind. Also, I wonder how many of those operating in the market for these dodgy products actually understood what they were getting themselves into, or selling. If those in the market didn’t know how could the regulators be expected to keep up.
Jack Strocchi.
No one minds you turning into Jack Stroppy.
Do exactly what Mr Denman says, take #60 and #66 and send them to the the AFR and every other newspaper in town. You speak brilliantly for a lot of us right now who are utterly disgusted by the extent of institutionalised embezzling that has been going on. If half or more of these institutions fail, and everyone who worked for them is on the street looking for a job, then I agree; good. Very good. I might then find an honest banker or a decent prudent financial adviser, no longer beholden to the greed embedded ethos of a shiny global empire, that I actually trust, opening up for business in my suburb.
A financial adviser who is actually working for me, not the commissions he gets from the financial services empire.
Ernestine,
Note – you seem to be trying to make an argument out of nothing. Exhibit one:
Can you please show anywhere that either S&P or Moody’s have given any postion at all on either of these issues. I cannot see any anywhere – i.e. you are trying to find an argument out of their “failure” to give a position that they clearly have nothing to say on. See any argument there? I cannot.
.
Jack,
I see some hypocrisy here. This whole thread is about S&P having the apparent chutzpah to downgrade an Australian state’s debt (How dare they after they got a class of debt wrong in the US!) and then you sling arrows at them for failing to downgrade Iceland fast enough. Before Iceland made the (possible) error of guaranteeing their various bank’s debt there probably was little chance of them defaulting on their national debt. Afterwards, the chances have gone up. And yet there is something wrong with recognising that if a State’s position deteriorates there is a slightly increased chance of them defaulting. Odd.
Incidentally, guys, a move from “AAA” to “AA+” is the recognition the chances have gone (in technical risk terms) from virtually zero to merely negligible.
As for “GW Bush, poster-boy for unregulated capitalism” all I have to say is “LOL!”. He was never, ever, that. He was (and presumably still is) a big government conservative. Odd – that sounds like the description you gave of yourself.
.
Alice,
As for “chas[ing] the financial scions and their temples out of the halls of government” I would loudly agree – I would just hope that the reverse also happens.
Andrew,
I hope the government actually gets the required level of testosterone to regulate the hell out of the embezzlers in the financial sector. Its long overdue.
Andrew @70, you are quoting out of context. The purpose of the sentences you quote in context is to show that my argument is not contradicted by S&P’s behaviour (if it would be, then you could shoot down my argument).
Jack, a nice rant. It is interesting though that the alleged dishonesty, embezzlement and parasitical behaviour is an a priori assumption in your book. The problem not all bankers are dishonest (shock, horror) and the GFC cannot be conveniently slotted away and attribited to excesses of capitalism, banker dishonesty and what not.
Bernie Madoff was sure a fraud. Lehman Brothers were not though. Incompetent, reckless, that’s for sure, but their criminality at this point only exists in fevered minds but not in reality. Well, at least, they were sort of unethical (and why on earth would we judge bankers by standards of ethics? Do we judge engineers in terms of their ethics? The police?). US home owners who bought into the property market at overinflated prices were neither dishonest not unethical. A bit silly, yes, but not dishonest.
So, you know, this entire line of thinking, ‘insitutional embezzlement’ and what not, is not only not borne out by the evidence, it is also not unhelfpul in understadning where this crisis came from or where we go from here. But, I see a pitchwork in my hand, must be time for witch-hunting.
P.S. this is not to say that the US banking system is a complete disgrace. Of course, they are and regulation – obviously – will need to improve. But, let’s leave higher-level philosophical ramblings aside, looking into the psychology of the FGC is a more fruitful way to analyse this.
Alice, re some of your earlier comments. It’s not about making money any longer, it is about not losing any.
‘Safe’ = straight Govt guaranteed saving accounts. Though you should spread any money between different banks.
For the immediate (intermediate?) future there are no investments that will make any money and all will expose you to unacceptable risk.
An option is to spend money on things that reduce your costs of living. E.g solar power/water heating, grey water use, etc. Anything that reduces your ongoing costs of living by a reasonable % will provide greater returns on investment than anything else at the moment (at least they will be positive with zero risk).
In bushfire terms, this is not normal bushfire where normal reactions work .. this is a firestorm, it moves faster than you can believe, its impact is greater than you can believe.
People focus on Bernie Madoff’s ponzi scheme, but in reality some of the largest firms in the global financial markets have a lot in common with Madoff. I doubt whether if you compared their daily activities you would find much difference between what Bernie did and what these CEOs did. Bernie isnt the only one like Bernie and it has been institutional embezzlement. There isnt any other word for it. Its an Enron, its a Long Term Capital Management, and it became “accepted practice” and widespread.
It is rot at the heart of the financial systems, it is not a mere pile of “errors of judgement”.
Eli at 73, I wouldn’t put my money on looking into the psychology of FGC nor on getting ethics consultants writing lists of corporate ethical behaviour.
Correction, Eli @ 74 rather than 73.
John g #66, that’s a good point. There was a moving staircase between the SEC and the likes of Lehmann Brothers and Bear Stearns in recent years.
Poorly paid, cardigan-wearing regulators were tempted over to the investment banks on 7-figure salaries to act as “consultants” on regulatory matters.
Now we are hearing from the history re-writing and forever blame-shifting neo-libertarians that it was all the fault of useless regulatory bodies for failing to spot the risks the banks were taking.
Well, duh, if you deprive them of resources for years and years, revoke the Glass-Steagall act separating investment banking from deposit-taking institutions, allow banks to bypass Basle capital requirements by shifting risk off balance sheet, allow 30 times leverage on instruments that the boards of most institutions couldn’t begin to understand themselves, allow the banks to parcel up dud debt with high-grade debt and flog it to the public as Triple-A rated securities using a rating system in which the raters are paid by the product engineers….well, yes, the regulators failed.
The truth is the neo-libertarians and flat earth efficient market fundamentalists, together with their rent boys in the IMF, pushed a trumped up half-baked ideology on the world for the past 30 years to mask their own self-serving greed. When it all blows up, they take the taxpayers’ coin. And THEN, they get their hack spin doctors to run talking points for half-educated financial advisers blaming it all on the regulators, governments and unions and “left wing” academics.
It will be a brave politician who opens his door remotely to these charlatans in future.
Of course, Mr. Denmore. How on Earth did we miss it? While all of this has been going on for the past 30 years the world has been mired in poverty, with nothing of any benefit to anyone has occurred as the wise, all seeing regulators have been stifled from pursuing the common good.
Oh – wait a minute. Vast amounts of wealth have been created? Billions (and it has been billions) of people have been lifted out of poverty? Despite a near-doubling of the population we have now reached dietary sufficiency for the first time in the history of the plant?
Where is that drawing-board? We may need to revisit your hypothesis.
Observa @ 38.
Maybe my irony detector isn’t working, but I’m happy to accept your praise and to stand up for absolute standards as against the postmodern relativism that dominates all sections of the political right.
Jack Strocchi @61
My comment @29 was a direct response to Ikonclast’s comment @27
“The finance industry is a parasitic superstructure. They don’t labour and they don’t manufacture. They produce nothing”.
So I don’t know where the so-called hasty construction and demolition of a straw-man comes in. You might want to read the context in which the comment was made before coming in with what amounts to nothing but pointless bluster.
As for postmodern conemporary finance, do you honestly think this is the first time the finance industry has run off the rails? As usual the problem has been easy money and poor regulation, with a great big splash of greed. This is nothing new, only the numbers are bigger.
Andrew says
“Oh – wait a minute. Vast amounts of wealth have been created? Billions (and it has been billions) of people have been lifted out of poverty? Despite a near-doubling of the population we have now reached dietary sufficiency for the first time in the history of the plant?”
Most of the world still lives on less than two dollars a day. Many nations dont have an internet connection, let alone participate in the global markets. Never have and never will. Approx 68 nations participate and thats it. Dietary sufficiency for the planet? What planet are you on?
I dont want to be rude but there are a lot of people who are sick to death of people telling us how rich we all became from the vast amounts of “wealth created” and “free markets”. It takes two people to work to pay off a house for most people Andrew, in Sydney, in Australia. 40 years ago it was achievable by one working blue collar or lower end wage. Get the real picture here. The very rich have become sickenly disgustingly rich on your so called “vast amounts of wealth” and the whole trickle down theory was a lie.
I dont know who you work for and I dont care, but there are now a huge amount of people in Australia who dont even have regular work (only casual or less than a desirable amount of hours per week).
Where is your drawing board? So far above everyone else’s you cant see the wood for the trees? You cant see that people look around themselves and wonder where all the fabulous wealth went (because it sure didnt come their way – and all they got was efficiency drives, less security, unable to get children minded, petrol prices through the ceiling, and now find their hard earned super extracted by the creators of this fabulous wealth they didnt share?
If globalisation and free markets is so great why does the US keep a wall to keep the Mexicans from looking for work there? Globalisation for capital and large corporate firms (the same firms that contributed to this mess) and who want to own and put an unreasonable price on the water of natives in impoverished villages.
This “fabulous wealth” we all shared is another fast buck lie Andrew.
“But Sean, that is explicitly what the S&P letter argues they do NOT do. Their claim in that letter is that all they are doing is assessing the likelihood of default, and the rest is none of their business.
And as you point out, the likelihood of Qld defaulting is utterly negligible. John’s point – that far from being impartial judges of risk they have a strong bias towards their ideologically sound friends – is spot on.” derrida derider @ 10.20am
The rating agencies have been pricing products and probability of default for years off the now faulty-assumption that guarantors will actually step in to rescue these product (bonds, ABS, CDOs etc). What they are now doing is assuming that the explicit or implicit guarantee might not eventually occur and this strips the risk of default down to how management, or in this case, politicans act. It is a realistic examination of what the policies would do to the economy.
The rating agencies are moving very rapidly from an overly optimistic model to an overly pessimistic model… not adhering to their ideological values or mates. I think that their rating downgrade just gives people an opportunity to buy an essentially safe government bond at higher interest rates than they are actually worth. But the ratings downgrade should wake up the political parties in Queensland and other states.
Alice,
I must have failed to notice the massive increase in deaths somewhere then. China perhaps? No – Over 1 billion people have moved from near-starvation to relative affluence in the last 30 years, even with a government that still routinely kills them for trifling offences. All they had to do was to open the ports.
India then? Nope, not there either. Again, nearly 1 billion people (now – only about 400m 30 years ago) and no routine starvation, indeed most of them now out of the one dollar a day category into the 2+ area that marks the start of the true lift out of poverty.
South America, then? Nope. Stupidly oppresive governments now largely replaced by reasonable democracies and (oops) open ports. There’s gotta be somewhere, then?
Oh, Africa. The last true domain of sheer hopeless poverty. That must be (if you are right) because they opened up to globalisation and listend to the IMF. Ahh, no. Lowest traded goods ratio, highest poverty. Odd.
Other than Africa, then, can you name anywhere that we have gone back from?
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As for Sydney, Alice – have you tried to compare the houses that were built in the 1960s to those of today? Unimproved, they typically have 2 bedrooms, a sleepout, one toilet, a bathroom and a kitchen with a rather quaint fridge.
Where is the TV? See that wooden box in the corner – we can get all three channels here! Must have had broadband, surely? No – no computer either. Queen sized bed? No – spring based double. Holden Commodore out the front, though. No – maybe we’re rich and have an HR Premier with those fancy side vent windows to keep you nice and cool. No. We’re poor working class and the old FJ will have to keep on going. Pity about them – no seat belts, and uncle Brian died when he had a crash in one at the normal speed to 40 miles an hour.
Pity is we are not rich, as that bloke Menzies brought in the credit squeeze in 1960 and we are only just recovering from it now.
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Alice I do not know which world you are living in, but it certainly is not this one if you imagine that normal people (anywhere on the planet) lived better in 1968 than they do now.
Andrew,
So you failed to notice the growth in private sector debt over the past two decades, whilst corporate sector debt and government debt has fallen? You dont think people build large spec homes because they cant get an extension (to a basic 3 bedder done more cheaply?). You dont see the plasma TVS purchased with debt on the family home from the lie of rising equity and the willingness of financial institutions to lend to “Ordinary Wage Joe” ( and advise him – yeah its fine to take a loan against your house – house prices never fall -youve got plenty of equity in it. We will even give you more? Do you want it?)
Then his loan and spending goes straight out of the economy to another economy – imports. Great – just sit back and watch the trade deficit rise.
I know what planet Im on Andrew but you need to get yourself down and look at ordinary Australians, not the billion or so Chinese who are now living out of poverty? For every one of those, there is a billion or so falling into poverty through globalisation. Its a croc. Oh and of course, the U.S., the greatest promoter of globalisation protectsn its own farm lobby groups whilst yelling for everyone else to lower their trade barriers.
The trouble with Australia is that it takes these nonsense free market theories on board, courtesy of mouthpieces like Andrew and wde sit back and watch the exit of Australian brands and Australian producers and Australian employers in search of cheap labour they can drive down elsewhere and when will they come back Andrew? When the world is full of cheap exploited cowed labour (that isnt free to globalise its own contribution to the production process, because they are living in a detention centre somewhere in a desert when they tried to?).
Im sick to death of hearing croc remedies by free marketeers with their croc theories.
Andrew conveniently ignores the Asian countries that lined up for IMF bailouts during the Asian crisis, victims of fast track capitalism and liberalisiation policies. Why has China done so well Andrew?; precisely because it didnt bow to the whims of free market theories and prescriptions and has kept strong control and doesnt jump when empty US rhetoric says jump like we do in Australia.
Financial capital de regualation played a role in this meltdown only the free markets proponents now want to turn around and say “it wasnt us.”
Last I heard, the IMF is broke. If its all going so well Andrew, why the hell is it broke? What about the interest on all those loans? Where did it go? Into default.
85#Andrew,
Even the IMF itself calls for greater regulation of the financial sector and recognises the role that lack of regulation played in this mess (yes, the free marketeers policy dispenser now acknowledges the flaw of excessive deregulation and there are calls to transform the IMF itself into a regulator of global financial markets) so are you missing something here?. Its time for us all to change the pat policy prescriptions in the wheelbarrow.
http://www.imf.org/external/pubs/ft/survey/so/2008/NEW092908A.htm
Alice, let’s conflate two different issues.
Insofar as developing economies are concerned, Andrew’s point is pretty hard to argue with: hundreds of millions of people have been lifter out of dire poverty into some soer of a respectable living over the past two decades. This can be primarily attributed to the opening up of the previously closed off economies in China, India, and South-East Asia. Development economics is a pretty fiery field these days but I think both Jeffrey Sachs and William Easterley agree on this basic point. So, free trade gets a tick in this respect.
Secondly, incomes have risen in the developed economies as well. This is trickier and more controversial and there are plenty of defitional debates that we can have but the broad point holds: we are better off that we were twenty or thirty years ago.
Then we come to the flip side of the free trade debate and here I think Alice has a point: despite the relative rise in incomes, this has been accompanied with a rise in inequality, both in the developed world AND in the developing economies. John mentions in his other post that median incomes have not risen as much as one would expect. So, we have a problem for the less educated blue collar and meddle class Americans, Europeans and Australians here. I recommend Paul Krugman’s recent writings in this respect: he gave a nice couple of lectures at the LSE last year that you can donwload via iTunes, highly informative.
Now, this is an interesting ethics debate: would you prefer to maintain Australia’s incomes leves by restricting free trade and committing Asi and Africa to eternal poverty or to share in the gains, as it were, by opening up trade, lifting the developing world out of property but sacrificing some of our prosperity in the process. This is not an easy debate to have but would venture to suggest that the mythical levels of properity Australian enjoyed back in the 50-80’s first of all never existed and secondly were not – and are not – sustainable from a political economy and resource-constraint perspectives.
“Now, this is an interesting ethics debate: would you prefer to maintain Australia’s incomes leves by restricting free trade and committing Asi and Africa to eternal poverty or to share in the gains, as it were, by opening up trade, lifting the developing world out of property but sacrificing some of our prosperity in the process.”
I fully agree that the distribution of wealth (and the related variable, income) globally is an interesting topic. However, frameing the ethical debates using the geopolitical term “country” is not helpful. Why should so-called low-income earners in ‘country A’, classified as ‘developed’, agree to have their income lowered to the level of low-income earners in ‘country B’, classified as ‘developing’, while the income distribution within each country continues to become more unequal?
I prefer to have the individual as the basic unit of analysis. However, given the corporatist version of a ‘market economy’ (a contradiction in some sense) that has emerged during the past 20-30 years in many countries, it seems to me that it is the corporation (the ‘enterprise’) which is a useful unit of analysis for the ethical debate on income distribution you wish to have.
JQ, I apologise for my last post in the sense that I had overlooked that the topic was shifting.
Ernestine #91 sums up Elis point well in paragraph one.
It is a pertinent question and one that I suspect will be answered through the political voting system within countries, not the globe.
World war one dampened the major episode of globalisation around the turn of the century as countries went inward to rebuild. The same scenario driven by different causes could well happen again. Globalisation is not something we can create and impose, its something that occurs naturally and can just as easily contract, but this last episode is lopsided anyway, debt reliant and ideologically bent (privatise public services and run budget surpluses no matter what the state of jobs) and a very poor excuse for free markets. If labour represents even 50% of the cost of a product, labour is not even permitted to globalise so as a free market theory, its just another straw man.
JQ (likewise – guilty of digression here as well. Ill leave globalisation there but it seems to me to be linked to the financial collapse and part of the problem of grossly inadequate regulation – of financial capital markets, taking a onme size fits all apporoach, and taking a very wide U turn back, is also evident in the complete lack of credibility, reliability and usefulness of ratings. In short, financial markets in shambles. Excessive deregulation to blame.)
Alice #92: and here we are in (almost) full agreement.
I warm in particular to the failure of regulation in a globalised financial world point. Precisely. In defence of the rating agencies, at least they are global entities better equipped in dealing with global risk management than the regulators (at least in theory).
90#Eli
My point is not at all to suggest we commit the African nations to poverty in order to maintain our own income, but I will ask the question – what is the point of our concern for the poverty of African nations, if in the process of adhering to free trade principles we impoverish our own nation? What would I then care if Africa gains?
That would be utterly foolish and unlikely. It runs counter to basic survival instincts. What would I tell my child? “Go and live in Africa? – oh sorry you cant. No one wants you, you would be a refugee”. If the mythical long run is then held up to sustain people’s ideological adherence to free trade principles here, with the rise of unemployment, such noble global free market principles wont last five seconds at the polls, and government is the expressed will of the people (unless you think it is more the will of corporate entities).
It may also have been the case that some African nations may have benefitted just as well and maybe more, not from free trade prescriptions but by small community co-operatives but it wasnt an option in the IMF policy manual.
Eli#93
Thats the theory Eli, you are correct, but once again it didnt seem to work out did it? (ratings agencies execs earn more hence MUST have MORE expertise than government, because their pay scale reflects their competitive MARKET value).
Somewhere there is a balance, with no easy white line drawn on a roadmap, between regulation and deregulation, free trade and protection OR OTHER solutions and between ideology and practicality (Ill call it the thinking economists universe).
What theory, Eli?
Ernestine # 96
Elis theory I referred to at 95 was his comment at 93
“In defence of the rating agencies, at least they are global entities better equipped in dealing with global risk management than the regulators (at least in theory)”.
Well, rating agency people don’t earn all that much. In fact, part of the problem is that they earn less than the investment bankers sitting across the table from them and there is a steady trickle of rating analysts quitting and joining the banks. End result: high turnover rates and inexperienced rating analyst and problems with maintaining intellectual independence (not easy where your next career move is to go join the guys who are trying to convince you to be more lenient on the rating).
But, still, ads I said, in theory, the agencies are globally integrated with much better internal coordination than the regulators. In practice, to be fair, they still have a better track record than the regulators and other international bodies, even after the subprime mess. It is all relative and the regulators have been failing for a long time and consistently. See, eg. Keating’s comments yesterday re Tim Geithner and the IMF.
o.k., Eli and Alice, your usage of the term ‘theory’ is incompatible with mine.
Alice,
You seem to imagine that free trade is somehow opposed to development. That is (almost) pure imagining. The history of growth in incomes is simple – increasing specislisation results in increased production, which results in increased incomes. Without trade between individuals specialisation is impossible.
What is true on the micro level is also true (in this instance) on the macro – if you want increased production per unit of input then specialisation and the trade that is essential for it to work is the best method of doing so.
I do not see it as helpful in any way to take a nationalist viewpoint that somehow free trade within a country’s borders is somehow a good thing while we need to be careful of what is over the border as it is somehow different and scary.
Nationalism of this sort has been argued and fought over many times and all that has resulted has been misery and death. I prefer not to go down that path.
This is shown clearly when you consider your sentence that “World war one dampened the major episode of globalisation around the turn of the century as countries went inward to rebuild…” This is not correct – World War 1 occurred after the “major episode of globalisation” had gone into retreat (if you doubt this examine the world trade figures in the lead up to the War). It was the retreat of globalisation that, in a very real sense, allowed the war to start.
As for your comments on the IMF I find them irrelevant. I express no surprise that a government body calls for regulation – this is like saying that most politicians believe in taxation. Interesting, but hardly a debating point.
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Eli,
Inequality is not (necessarily) a bad thing and to act as if a rise in inequality is a reason to abandon development is to truly throw the baby out with the bathwater. If everyone in an economy (apart from the President and a few mates) is on $1 per day and if trade results in half of the people getting $2 and others getting $10 then there has been a rise in inequality, but I fail to see this is a problem.