23 October 2008

Credit Rating Agencies & Cows

I think Waxman may finally have blundered into something important.

Henry Waxman has been excoriating Wall Street and all who have any connection therewith in recent weeks from his post as chairman of the House Committee on Oversight. For the most part, the hearings have been the standard look-like-I'm-doing-something stuff.

Were I a cynic, I might suggest that there's an element of shake-down in them, too. Of course my faithful readers know better than to suggest I'm one of those.

At one point, though, Waxman had scheduled a hearing for Oct. 16 in which he expected to have several of the most prominent hedge fund managers in the world testify on the question: whether excessive speculation had contributed to the present financial crisis. Soros was going to be there, Simons, Griffin, and others of that ilk.

On October 14, Waxman announced the delay of that hearing until November 13. Cynical minds suggested that he was telling those witnesses and other speculator types, "hey, we've got an election coming up. You may have noticed. Its been in most of the newspapers. There's still time to get a check to our campaign committees. The size of the contributions you make may correlate inversely with the intensity of the question you'll face when we do get around to this post-election hearing thingy."

Anyway, as I say, he may have blundered into something. Yesterday's show was entitled "Credit Rating Agencies and the Financial Crisis."

There is a powerful case to be made that the credit rating agencies have had an inherently conflict-prone business model, and that this has introduced an element of instability into the US financial system in recent years. In short, they're paid by the issuers they rate. If they rate an issuer's garbage AAA, that issuer will presumably give them repeat business. If they downgrade, the issuer has had the option of shopping around for a higher rating elsewhere. So there's been a race to the bottom, and anyone can get a AAA.

The above paragraph is a very simplistic statement of a very complicated matter, but there is enough truth to it to be disturbing. I'm glad Waxman and his colleagues grilled some agency execs on this subject.

Efforts at reform in this field have been underway for some time. But its been one of those policy-wonk things for a small circle of professional ponderers. It is just as well that this has gone mainstream.

And those cows! The committee unearthed an i-m exchange that crystallizes the situation in a way that makes wonks and non-wonks both laugh out loud.

Two of the analysts at the largest of the raters, rating agency Standard & Poor's, started gossiping about a year and a half ago. It went thus:

"That deal is ridiculous," Rahul Shah, wrote.

"I know right ... model def. does not capture half of the [risk]," Shannon Mooney replied.

"We should not be rating it," Mr. Shah said.

"We rate every deal," Ms. Mooney wrote. "It could be structured by cows and we would rate it."

Insert your own e-Cow-nomics joke here.

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Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.