Writing in the National Interest

by John Quiggin on August 18, 2011

The National Interest has just run a piece I’ve written on the S&P downgrade. I had understood this was a conservative publication, but I tend to got lost in the varieties of US conservatism (and, for that matter, liberalism). Anyway, they seemed happy to run this as well as an earlier piece on Europe. A quick look at the website didn’t suggest I was in bad company – most of the foreign policy stuff was anti-war, and the other economic pieces were eclectic.

Is there an up-to-date guide for overseas visitors to the US scene? It’s nice to be called up from the Australian farm team, but I don’t want to end up in some glossy publication that turns out to be funded by LaRouche.

{ 63 comments }

1

Sandwichman 08.18.11 at 4:15 am

NI was founded by Irving Kristol but apparently has moved away from neo-conservatism to a position that used to be known as “establishment Republican.” I picked up a copy at an airport news stand last year that had some thoughtful articles in it. I think you’re safe on the LaRouche angle.

2

John Quiggin 08.18.11 at 4:48 am

I guess “establishment Republican” circa 1980 corresponds to “professional left” today.

3

geo 08.18.11 at 5:12 am

Should one really worry where one’s stuff appears? After all, your writing always enlightens, and who needs enlightening more than La Rouchies do?

4

Ben 08.18.11 at 5:44 am

They at least have a balanced approach to Crooked Timber. The same issue with the Quiggin byline has an article titled “Henry Farrell Should Know Better.”

5

hartal 08.18.11 at 7:02 am

Who are these bondholders? As DeLong has been pointing out, the American wealthy have diversified portfolios; they are not the coupon-clipping rentiers whom Lenin targeted, and do not stand to gain from austerity policies that dim profit prospects and thus equity values. If one were looking for a real group that could be described as bond holders, that would be the Chinese government worried about the headline inflation and a deterioration in the quality of payments on US treasuries that the monetization of runaway US debt would engender. There was an interesting piece by Roach titled “Read China’s Lips”.

6

Kevin Donoghue 08.18.11 at 8:11 am

My impression is that The National Interest is mainly about ‘Realism’ as that term is used in International Relations Theory. So economic growth is important, since you need it to support miltary might. But manufacturing matters more than banks. Keynes is good, he’s the man who wrote How To Pay For the War. Small wars are usually bad, it’s the likes of China you should worry about, not Iraq or Iran.

I’d say reach out to that audience by all means. But don’t be surprised if your calls for fiscal expansion are cited in support of more aircraft carriers.

7

otto 08.18.11 at 8:50 am

The one to really avoid is the New Republic, a conservative journal aimed at laundering justifications for jewish colonialism into American ‘liberalism’.

8

J. Otto Pohl 08.18.11 at 9:47 am

Historically in the US support for Israel has been a liberal and even leftist cause. The TNR fits in on the liberal side of the US spectrum. Up until recently critics of Israel in the US tended to be conservatives. They were people like Patrick Buchanan, Robert Novak and Joseph Sobran. The neo-conservative movement with its radical Zionism only came about in the late 1970s and was really represented by Commentary Magazine. One still sees a lot of liberal and leftist support of Israeli colonialism in the US, particularly among academics, journalists, and elected officials. I suspect that the triumph of identity politics over all other modes of thought among the US left plays a big role in the continued maximalist support of Israel demonstrated by many American liberals.

9

ajay 08.18.11 at 11:22 am

Up until recently critics of Israel in the US tended to be conservatives.

Really? What about the people who supported the Palestinian cause? Noam Chomsky, etc? Surely that wasn’t primarily a conservative cause?

10

Uncle Kvetch 08.18.11 at 12:14 pm

most of the foreign policy stuff was anti-war

And so it shall remain, until there’s a Republican back in the White House.

11

Barry 08.18.11 at 12:28 pm

J. Otto Pohl 08.18.11 at 9:47 am

” Historically in the US support for Israel has been a liberal and even leftist cause. ”

‘Historically’ in this case means ‘back in the long long ago, but not now’.

“The TNR fits in on the liberal side of the US spectrum. ”

Have you read it? In the past thirty years, I mean.

12

Kevin Donoghue 08.18.11 at 12:47 pm

Uncle Kvetch, AFAICR articles in The National Interest on the invasion of Iraq were mostly anti. (Or maybe they were the articles I was most likely to notice.)

13

Shane Taylor 08.18.11 at 1:19 pm

In addition to your piece, National Interest runs some quality work. There was an excellent (and damning) review of Sam Harris’s latest book.

They also run pieces by David Rieff and John Gray, for those interested.

14

salazar 08.18.11 at 1:47 pm

I’m with Barry. The New Republic mostly features Joe Lieberman-type center-right opinions. On occasion, it finds common ground with the far-right.

15

roac 08.18.11 at 1:52 pm

Once you have seen a few LaRouche publications you can spot one at twenty yards, before any of the text is actually legible.

LaRoucheism is not a political movement at all, but a scam pure and simple. It is much the same deal as Scientology, except that Hubbard was smart enough to see that labeling your scam as a religion immunizes you against prosecution (in the US, anyway). I am proud to say that the guy who succeeded in locking LaRouche up for securities fraud was a law school classmate of mine.

16

LFC 08.18.11 at 2:44 pm

The National Interest should not be confused with The American Interest[1], though at this point I don’t know whether the differences between them are that significant (since I don’t read either regularly enough to say). Kevin, above, is I think correct that NI originally self-identified as “realist”. E.g., the Winter 1992/93 issue of NI, which happens to be on my shelf, contained a piece by Zakaria called “Is Realism Finished?”. His answer, of course, was ‘no’.

1. From Wikipedia: “In 2005, 10 of the 14 members of NI’s editorial board, led by Fukuyama and upset by the Nixon Center’s changes to editorial policy, decided to leave the journal and create a rival publication, The American Interest.”

17

Uncle Kvetch 08.18.11 at 3:06 pm

Uncle Kvetch, AFAICR articles in The National Interest on the invasion of Iraq were mostly anti. (Or maybe they were the articles I was most likely to notice.)

I stand corrected — thanks, Kevin.

As for TNR, my impression is solidly Likudnik on Israel, generally interventionist on foreign policy, tepidly center-left on domestic issues. Label that as you will — it may or may not qualify as “liberal” (a term that is gradually being bleached of any substantive meaning in the US) but I’d say it represents a broad swath of the current Democratic Party, including Obama and the Clintons.

18

salazar 08.18.11 at 3:29 pm

Uncle Kvetch: “I’d say [TNR] represents a broad swath of the current Democratic Party, including Obama and the Clintons.”

As shown by the publication of “The Bell Curve” essay in 1995?

19

Ed 08.18.11 at 4:59 pm

Fascinating to see how misinformation spreads. Not only did you bring up the Enron and Worldcom nonsense (ratings are probabilities and can’t be proven wrong by single events!) and you ignored the actual evidence that shows that sovereign ratings have a great track record (including reports from the IMF and research by Reinhart on this topic), but you also managed to create a conspiracy theory where S&P’s actions are part of some global plot. The purpose was to ‘lock in bipartisan commitement’? Wherever did you get that from?

20

Carter 08.18.11 at 6:00 pm

“I don’t want to end up in some glossy publication that turns out to be funded by LaRouche.”

Why not? You agree with him:

“the rating agencies…are attacking the U.S. government without providing any proof of their assessment, in a totally arbitrary way”

http://www.larouchepac.com/node/18941

21

bianca steele 08.18.11 at 7:20 pm

On TNR: tepidly is the key word. They will give you every reason why the Republicans are reasonable to oppose the policy, and . Presumably helpful if you’re a liberal wonk, not so helpful if you want to know the liberal side of the story.

Culturally, though they have some interesting (often younger) writers, they are still in the old PR/Commentary line.

I think they get some slack for their support of Likud because they are able to blame Peretz for requiring that as a condition of keeping their jobs.

As for the LaRouchites, maybe they aren’t accusing Milton Friedman, Jimmy Carter, and the Queen of being drug traffickers anymore.

22

John Quiggin 08.18.11 at 7:20 pm

@Carter Umm, yeah. That is kind of the point. Given LaRouche’s bizarre spread of views most people, including me, are going to agree with him about something. This doesn’t mean I want them to be presented as part of the case against the genocidal plots of the House of Windsor.

23

Nine 08.18.11 at 8:46 pm

“ratings are probabilities and can’t be proven wrong by single events”

I am totally going to adapt this excuse to my work situation !

24

Ed 08.18.11 at 8:49 pm

I am totally going to adapt this excuse to my work situation !

Depending on what you do for a living I’m pretty sure you already do.

25

roac 08.18.11 at 8:50 pm

Yeah. They said the Titanic was unsinkable, and statistically, they were right!

26

Ed 08.18.11 at 8:53 pm

Actually roac, let’s try and use the right analogy. In this case it would be like a company that says that among certain type of ships only X% would sink over a certain period. You know, like what insurance companies do to price their policies?

27

John Quiggin 08.18.11 at 11:26 pm

You can set us straight then, Ed. Of the major corporate failures in the dotcom crash, what proportion (by numbers and value) were signalled well in advance by ratings downgrades. As I recall, Enron and Worldcom were the two biggest, and were missed completely, but my memory may be faulty.

28

Donald Johnson 08.18.11 at 11:48 pm

“As shown by the publication of “The Bell Curve” essay in 1995?”

That’s the “contrarian” image they like to project, related to the “Even the New Republic” catchphrase (as in “Even the New Republic supports the contras and the MX missile.”) It showed their feisty independence of the dogmatism of the anti-racist left. People are forever showing their feisty independence of the left–I wish the left had enough power to make this sort of posturing indicative of true courage, but it doesn’t.

Slate used to do the same thing, back when I read them.

29

Ed 08.19.11 at 12:03 am

John,

I think we’ve debated this before, not sure this time it will make a difference. But here it goes again.

1. If you are going to argue that sovereign ratings have a bad record, then don’t bring up Worldcom or any other corporation. Or MBS ratings either. These are all very different groups with completely different methodologies. It’s like assuming that because in some university their Political Science department has certain characteristics then the same should apply to their Economics department.

2. Ratings are meant to rank order credit risk, which means they are probabilities. Which also means, and you don’t need me to point this out, that you can’t judge the results by looking at individual cases. A good analogy is from the personal credit scoring industry. If I have a high credit score that does not mean I will always pay my credit card bills, rather it means that there is a strong likelihood of that happening.

3. If you look at the historical evidence sovereign ratings have a very good track record in rank ordering credit risk. Please don’t bring up that awful piece by Nate Silver as a counter argument. If you are interested you can read what the IMF wrote about this recently, or what many other academics, like Carmen Reinhart, have written in the past.

A more sophisticated argument against ratings is that even if they rank order credit risk correctly the market does the same and much faster. We can debate that if you want. But the problem with market measures is that they are much more volatile, and have predicted 25 of the last 3 defaults.

Finally on the US rating, note that the credit markets agree with S&P.

30

Reality Cheque 08.19.11 at 1:09 am

Ed and John, The ratings of little fish, in normal times, has probably been fine. Of course, little fish have limited influence and cash flow with which to grease better ratings. Whales, however, are another matter entirely.

31

Reality Cheque 08.19.11 at 1:24 am

By the way, I enjoyed the attempt to belittle you, as an academic economist, by describing you as a member of the ‘Australian farm team’ given that agricultural economists have produced some of the best empirical work, in terms of thoroughness, and care to attempt to reflect reality rather than passing theoretical fantasy. Again, with critics like that who needs friends!

32

Tony Lynch 08.19.11 at 1:38 am

Didn’t ratings agencies up to the turn of the Century mostly concern themselves with rating corporate bonds? And didn’t the trouble start wshen, after that, and for various reasons, they got into rating mortgage-backed securities? (Where the incentives were all wrong for accuracy and reliability?)

33

geo 08.19.11 at 1:55 am

Ed: Ratings are meant to rank order credit risk, which means they are probabilities. Which also means, and you don’t need me to point this out, that you can’t judge the results by looking at individual cases. A good analogy is from the personal credit scoring industry. If I have a high credit score that does not mean I will always pay my credit card bills, rather it means that there is a strong likelihood of that happening.

It’s probably not fair to the rest of you to get Ed started on this again, but it seems to me there’s an obvious fallacy in the above paragraph. If you have a high credit score and then default spectacularly on your bills, doesn’t that mean that whoever gave you the high credit score missed something important when rating you highly? If the ratings agencies said that Enrom and WorldCom were less likely to fail than most other corporations, then they missed something important, no? Doesn’t that reflect badly on their competence?

34

CBrinton 08.19.11 at 2:19 am

It would be a good thing if there were reference works showing which publications are non-whacko. If you’re from a different country it can be quite hard to tell on the basis of just a couple of issues.

(I concur with the others who have said the National Interest is definitely sane).

On the New Republic: the catchphrase, in my experience, is normally rendered ““Even the liberal New Republic” [supports some neoconservative position].

35

Ed 08.19.11 at 2:22 am

If you have a high credit score and then default spectacularly on your bills, doesn’t that mean that whoever gave you the high credit score missed something important when rating you highly?

No, it doesn’t mean that at all. That’s why it’s a probability. The only way to check is to look at all the people with the same credit and see how they fared.

36

Reality Cheque 08.19.11 at 2:42 am

A important part of the failure of rating agencies when it came to mortgage backed securities might have been the seeming implicit belief that the Credit Defaults Swaps were valid and not, in fact, worthless if there was a significant downward movement (or even holding pattern) in house prices. Unlike the highly regulated insurance industry, those issuing the CDSs didn’t have anywhere near the reserves necessary to back them up. Also, they massively underpriced them. That is why the triple AAA bundles the finance industry synthetically created were ‘cheap’ and hence brought by ‘astute’ buyers all around the world, thus funding more sub-prime mortgages. Not unlike a Ponzi scheme; seemly, everyone was getting something for nothing. In fact, they were paying something for nothing as it turned out.

As the insurance industry could have provided the same insurance that CDSs provided, the only reason for creating CDSs was a legal one, to avoid the regulation and scrutiny the insurance industry is subject to. Also, risks are assessed by actuaries in the insurance industry, rather than cowboys, cowboys being the preferred assessors in the finance industry.

However, maybe, as the latest evidence seems to indicate, some of those assessors actually correctly assessed the risks of mortgage backed securities but were overridden by their ‘managers’. Bad ratings were bad for business; good ratings were good.

37

b9n10nt 08.19.11 at 3:49 am

what Ed would need to tell us in order to inspire confidence in S&P is this: we know of spectacular missed calls (the aforementioned Enron, WorldCom, and M-b Ss). Are there commensurately accurate yet novel predictions that give some reason to believe the rating agency’s methodology has some utility?

38

geo 08.19.11 at 4:30 am

Ed: The only way to check is to look at all the people with the same credit and see how they fared

Which should be extremely easy to do. But first, let’s be clear about probability. If Enron and WorldCom were rated at, say, the 90th percentile in the rankings (assuming 100 to be perfectly safe and creditworthy), then firms at, say, the 10th percentile ought to have failed as spectacularly around 9 times as often, if the ratings were sound. Is that correct?

And if that is correct, are you actually suggesting that that’s what happened?

39

John Quiggin 08.19.11 at 4:37 am

At a minimum, I think it’s clear that, whatever successes there are to put on the positive side of the ledger, my statement that the agencies failed in the dotcom crisis (not as much as the peddlers of equity, but still spectacularly) is consistent with the evidence and not, as Ed initially claimed “misinformation:.

40

Myles 08.19.11 at 4:45 am

And if that is correct, are you actually suggesting that that’s what happened?

More or less, yes. Companies which enjoyed about equivalent hypothical rankings to Enron and WorldCom failed quite a bit less than companies which enjoyed substantially lower rankings. There’s nothing wrong with this. Indeed, logic dictates that there had to be failures at that level (e.g. Enron and WorldCom), because 10% still have to fail.

If you have a high credit score and then default spectacularly on your bills, doesn’t that mean that whoever gave you the high credit score missed something important when rating you highly?

Absolutely not. Credit ratings reflect expected outcomes, not actual outcomes. The first thing one is taught in statistics is that actual outcomes, in discrete cases (and especially in individual cases), rarely, if ever, reflect the expected outcome.

For example, if you have a 25% chance of winning a million dollars, your expected outcome is $250,000. But of course, you won’t actually get that sum, because you’ll get either zero or $1-million. But the expected outcome isn’t wrong; it’s just the expected outcome. It’s an useful statistical output for aggregated risk analysis.

41

b9n10nt 08.19.11 at 4:45 am

Ahem…marginal utility. I think this is a flaw of an analysis that rests alone on S&Ps ability to reflect accurate probabilities of securities’ default. S&P must be better than a mere reflection of CW if it is to be institutionally justified either as a market participant or a public good. Probability isn’t novel unless it’s finer-grained than the probabilities everyone else works with.

Prima facie (i.e. Thus requiring more extraordinary evidence from Ed, see above): It’s not immediately apparent that S&P is a relevant market actor in it’s supposed role as legitimator of credit. What’s happening to US bonds since the downgrade?

This leaves us with the question: what is the public good that this bundle of socio-material relations named Standard and Poor’s serves? What product is benefitting which public? An impartial observer would want to start by looking at their effect on politics.

Now we begin…

42

geo 08.19.11 at 4:54 am

As usual, dear Myles, you’re completely, charmingly wrong. In the case you cite, of a random drawing for $1 million, there are no qualifications that will influence your probability of winning the prize. It’s sheerly a matter of chance. In the case of credit ratings, however, the ratings do indeed have to be earned. What a 90th percentile rating means is that all the firms rated have been investigated, and that 9 times as many firms at the 10th percentile will fail as at the 90th percentile, in your judgment, because of what you have found out in the course of your investigation. There is nothing random about it.

43

Kenny Easwaran 08.19.11 at 5:02 am

Shane Taylor – I liked the first page or so of the review, but it ends by blaming Sam Harris for Glenn Beck, which seems a bit much. Some of the criticisms were good, but some seemed like just the standard promotion of religion that one finds in mainstream reviews of “New Atheist” books, that only half the time get at some of the actual problems.

44

Reality Cheque 08.19.11 at 6:44 am

I’d have to agree that the rating agencies failed with the dot coms. The rating agencies successes have been where assessment has not be very difficult – small entities, where there are a lot of similar entities, and during times that are relatively normal. Success where their has been little merit in their success.

Where the task was harder, their record is not good. The problem with dot coms was that they were new, of a type they were not familiar with, and the times, especially for those entities, were not ‘normal’, as times never are at the beginning of rapid innovations.

45

Barry 08.19.11 at 12:49 pm

Ed: “No, it doesn’t mean that at all. That’s why it’s a probability. The only way to check is to look at all the people with the same credit and see how they fared.”

Spectatcularly wrong, since one of the things that an honest rating agency would do is to check the audits, when rating very large firms. The pool is too small for statistical analysis.

I also note that you’ve been asked for support of your claims in this thread, and haven’t provided any.

46

Ed 08.19.11 at 1:05 pm

my statement that the agencies failed in the dotcom crisis (not as much as the peddlers of equity, but still spectacularly) is consistent with the evidence

No John, it is not. You have provided no evidence. I already explained you don ‘t disprove probabilities with single events.

47

Ed 08.19.11 at 1:09 pm

If Enron and WorldCom were rated at, say, the 90th percentile in the rankings (assuming 100 to be perfectly safe and creditworthy), then firms at, say, the 10th percentile ought to have failed as spectacularly around 9 times as often, if the ratings were sound. Is that correct?

Yes, with one caveat. The probabilities are not linear so all rating agencies are saying is that a higher rated credit is less likely to default, but not exactly how much less likely.

48

OldSole 08.19.11 at 4:05 pm

@LFC: So Fukuyama wanted to use a designated hitter and Nixon wanted to let pitchers hit?

49

salazar 08.19.11 at 4:53 pm

“That’s the “contrarian” image they like to project, related to the “Even the New Republic” catchphrase (as in “Even the New Republic supports the contras and the MX missile.”) It showed their feisty independence of the dogmatism of the anti-racist left.”

That’s exactly right. TNR’s a solid center-right opinion publication.

50

Barry 08.19.11 at 4:56 pm

Ed,

(1) Still waiting on your evidence,
(2) ‘nonlinearity’ only goes so far, or it becomes an excuse for failure. And unless Enron and WorldCom were rated the most likely to fail among large companies, nonlinearity wouldn’t even apply.

It’s fun to watch you just assert and assert and assert, when it’s clear that you don’t have proof for sh*t, and you don’t even have logic on your side.

I would hope that you are getting paid for this, but I think that you’re a standard right-winger, always ready to do some free pro richo work for your betters.

51

Ed 08.19.11 at 5:22 pm

Barry,

Evidence of what? Of the record of sovereign ratings?

52

Myles 08.19.11 at 5:27 pm

In the case of credit ratings, however, the ratings do indeed have to be earned. What a 90th percentile rating means is that all the firms rated have been investigated, and that 9 times as many firms at the 10th percentile will fail as at the 90th percentile, in your judgment, because of what you have found out in the course of your investigation.

Au contraire, credit ratings are almost a perfect case of conditional probability. There’s a pretty good probability that you won’t default on your credit card debt given a 650 credit score, but there is no guarantee. It merely indicates that given the constraint of a high credit score the peak in the probability function is located at a region where, if default = 1 and non-default = 0, it’s located somewhere in the vicinity of 0. But the tail of that function might well extend into 1. If (hypothetically) say, a person with a credit score of 650 has a 5% of default, that means 5% of people of 650 credit scores will still default, if the statistical model is any good.

What your credit score indicates is the expected outcome of all people with a similar credit score. It has no predictive capabilities whatsoever beyond this. So if a bank has 1000 customers with 650 credit scores, the averaged behaviour of the 1000 customers will equate to exactly as one would expect from a credit score of 650, plus or minus the margin of error. But the credit score of 650 says absolutely nothing about the discrete outcome of each of the those 1000 cases, although it does do a pretty good job of indicating the confidence interval of behaviour being concordant with what one expects from a credit score of 650.

53

Ed 08.19.11 at 5:36 pm

b9: It’s not immediately apparent that S&P is a relevant market actor in it’s supposed role as legitimator of credit. What’s happening to US bonds since the downgrade?

Ratings are an assessment of credit risk, not bond yields. If you want to compare the market’s view of the US credit risk with that of S&P you need to look at a market measure of credit risk, ie CDS spreads.

54

geo 08.19.11 at 6:47 pm

Good try, Myles, but once again you’re conflating a random happening like the probability of winning a drawing with an earned ranking, which of course is only approximately precise but is not random. To calculate the probability of someone winning a drawing, you don’t need to know anything about the person, only the size of the pool. A rating, on the other hand, is a prediction — supposedly based on careful comparative investigation of the structure, finances, personnel, etc. of various companies — that those companies with, say, a 90 rating are roughly 9 times more likely to survive an unforeseeable adverse event of a given magnitude (eg, an economy-wide rise in interest rates) than companies with a 10 percent rating. The kind of careful comparative evaluation needed to responsibly make such a judgment clearly was not done in the cases of Enron and WorldCom, or it would likely have been discovered that their corporate finances were a shell game.

55

Ed 08.19.11 at 7:17 pm

Geo,

You are arguing about something different than what I brought up with John. But let me make a clarification. Ratings carry disclosures that, among other things, explain that they are not auditors. Ratings explicitly say they do not measure for fraud. You seem to want a different product, which is fine, but it is not what rating agencies do.

56

geo 08.19.11 at 7:33 pm

I see. Thanks.

57

Consumatopia 08.19.11 at 7:53 pm

If all one is aiming to do is segment borrowers into an ordinal ranking of groups depending on how likely they are to default, that shouldn’t be very difficult. As long as you could divide the market into two groups, with defaults happening more often in the first group than in the second, then you can create groups that are in between these two groups by randomly picking members of the two groups and sticking them together.

I would hope that the CRAs could do better than this, but if all you want is to produce a list of groups of companies ranked by credit risk, mission accomplished.

58

Ed 08.19.11 at 8:21 pm

If all one is aiming to do is segment borrowers into an ordinal ranking of groups depending on how likely they are to default, that shouldn’t be very difficult.

In that case it will be easy for others to compete then, no?

59

Consumatopia 08.19.11 at 8:54 pm

If that was all they were offering, then, yes, it would be.

60

Myles 08.20.11 at 2:53 pm

Good try, Myles, but once again you’re conflating a random happening like the probability of winning a drawing with an earned ranking, which of course is only approximately precise but is not random.

It is not a earned ranking. It is not an earned ranking. It is not an earned ranking. You cannot rank something in a way where the number of parties receiving each particularly rank is entirely within discretion. Even your credit score isn’t really much of an earned ranking. In any case, there are no objective way to actually rank countries and corporate entities; you can sort them into broad registers.

A rating, on the other hand, is a prediction—supposedly based on careful comparative investigation of the structure, finances, personnel, etc. of various companies—that those companies with, say, a 90 rating are roughly 9 times more likely to survive an unforeseeable adverse event of a given magnitude (eg, an economy-wide rise in interest rates) than companies with a 10 percent rating.

As others have observed, first of all, that linearity condition is not presumed. Second, this still means that of the companies (hypothetically) rated 90, some will catastrophically fail. This is in the nature of the very rating given. This is why a 90 rating isn’t a 100 rating. The debate is whether Enron and WorldCom are within the confidence interval of expected failures for 90-ratings. I really say they aren’t too out of the ordinary.

The kind of careful comparative evaluation needed to responsibly make such a judgment clearly was not done in the cases of Enron and WorldCom, or it would likely have been discovered that their corporate finances were a shell game.

If they were cooking their books, then by definition the books were cooked, and the responsibility falls not on the people cheated by cooked books but by people who cooked the books. The ratings agencies can only rely on the information which is available to them. The ratings agencies are not superhuman.

61

geo 08.20.11 at 4:24 pm

Sorry, Myles, old fellow, but your first two points seem to me to consist entirely of hand-waving. No one in any of these discussions has ever been ignorant of the elementary point you are jumping up and down and shouting yourself red in the face to make: namely, that even some firms with a high rating will fail.

The whole question turns on what the ratings were based on: ie, whether the agencies had any responsibility to do anything other than evaluate the information provided them by the companies rated, taking their accuracy for granted. Ed says no. Assuming further that Enron/WorldCom did indeed provide the ratings agencies with fraudulent data, then that settles the matter, I suppose, albeit to no one’s satisfaction.

62

Myles 08.21.11 at 2:07 am

The whole question turns on what the ratings were based on: ie, whether the agencies had any responsibility to do anything other than evaluate the information provided them by the companies rated, taking their accuracy for granted.

If the ratings agencies are liable to evaluate information not officially and upfrontly provided to them, then you would have opened up a whole can of worms where they become liable not just for the interpretation of financial and industrial data but meta-analysis of reliability thereof and the discounting following therefrom. This isn’t what the credit ratings agencies are for; heck, you’d have to pay them a lot more for them to sign up for that kind of thing.

I understand and sympathize with your desire to see ratings agencies provide ratings that are in fact more useful and realistic for the purpose of allocating investments and economic resources, but I do think there are intrinsic constraints on how something like alphanumeric categorization can be made useful in this context, and that the more we infantilize investors in this manner the worse the shocks when they come. (For example, the Germans lost money to Wall Street largely because they were incompetents looking to squeeze an easy buck from high-yielding yet purportedly highly rated safe assets, without doing their due diligence. The solution is not to provide them with even more due diligence-avoiding ratings, but for them to actually buckle up and do their homework.)

63

LFC 08.21.11 at 2:29 am

OldSole:
@LFC: So Fukuyama wanted to use a designated hitter and [the] Nixon [Center] wanted to let pitchers hit?

It’s fairly well known that Fukuyama had a falling out with some of his erstwhile neocon confreres over Iraq (among other things, perhaps), but I’m not sure precisely how that relates to the National Interest/American Interest thing. There may have been differences over issues of, arguably, more import than your baseball analogy suggests. I don’t know. As I said, neither journal is one that I read more than occasionally. (I believe, fwiw, that members of the CT group have contributed to both journals. H. Farrell had a book review-essay in the AI not too long ago, which he blogged about here; it was a review, iirc, of James Scott’s latest book and of a Benedict Anderson book.)

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