What is the Sociology of Ratings Agencies?

Lots of talk across the blogosphere regarding Standard & Poor’s “downgrading” of US Treasury debt.  But let’s recall the source.

Standard & Poor’s, together with Moody’s, is one of the great dupes of the recent financial crisis (villains, if you are more cynical).  It repeatedly issued AAA ratings to what we now know — and what any sharp-eyed reasonable observer then should have known — to have been toxic waste.  Highly speculative mortgage-backed securities and other CDOs were repeatedly given clean bills of health when they were full of mortgages doomed to foreclose.  What’s more, very high percentages of these CDOs were put in the AAA tranches, sometimes as high as 90%: how in the world can 90% of these things be in the very safest tranche?  It put Lake Wobegon to shame.

None of this means that the S & P “finding” is irrelevant.  Rather, it is to say that merely because S & P says something does not make it true or even slightly profound.  S & P analysts have biases and blind spots just like anyone else — and in fact, they may have more than anyone else because they exist in a world of high finance with little connection to on-the-ground realities.  As high finance people, they also have political biases: somehow, S & P came out with this in 2011, but didn’t utter a peep in 2001 (Bush tax cut I), or 2003 (Iraq war), or later in 2003 (second Bush tax cut), or 2005 (Medicare Advantage), or late 2010 (tax cut deal).  The Affordable Care Act according to the CBO will substantially cut the deficit, but nary a word from S & P.

S & P is not a machine; it’s a collection of very flawed people.  Like most people on Wall Street, their analysts put their hats on one horn at a time.  We just need to remember that.  And some enterprising sociologist might have an interesting paper in locating the “systemic risk” of error in S & P”s ratings.

Author: Jonathan Zasloff

Jonathan Zasloff teaches Torts, Land Use, Environmental Law, Comparative Urban Planning Law, Legal History, and Public Policy Clinic - Land Use, the Environment and Local Government. He grew up and still lives in the San Fernando Valley, about which he remains immensely proud (to the mystification of his friends and colleagues). After graduating from Yale Law School, and while clerking for a federal appeals court judge in Boston, he decided to return to Los Angeles shortly after the January 1994 Northridge earthquake, reasoning that he would gladly risk tremors in order to avoid the average New England wind chill temperature of negative 55 degrees. Professor Zasloff has a keen interest in world politics; he holds a PhD in the history of American foreign policy from Harvard and an M.Phil. in International Relations from Cambridge University. Much of his recent work concerns the influence of lawyers and legalism in US external relations, and has published articles on these subjects in the New York University Law Review and the Yale Law Journal. More generally, his recent interests focus on the response of public institutions to social problems, and the role of ideology in framing policy responses. Professor Zasloff has long been active in state and local politics and policy. He recently co-authored an article discussing the relationship of Proposition 13 (California's landmark tax limitation initiative) and school finance reform, and served for several years as a senior policy advisor to the Speaker of California Assembly. His practice background reflects these interests: for two years, he represented welfare recipients attempting to obtain child care benefits and microbusinesses in low income areas. He then practiced for two more years at one of Los Angeles' leading public interest environmental and land use firms, challenging poorly planned development and working to expand the network of the city's urban park system. He currently serves as a member of the boards of the Santa Monica Mountains Conservancy (a state agency charged with purchasing and protecting open space), the Los Angeles Center for Law and Justice (the leading legal service firm for low-income clients in east Los Angeles), and Friends of Israel's Environment. Professor Zasloff's other major activity consists in explaining the Triangle Offense to his very patient wife, Kathy.

7 thoughts on “What is the Sociology of Ratings Agencies?”

  1. I had exactly the same thought yesterday. If our entire financial system is in the thrall of a certain Ayn-Randian economic idea, and if economics professors and Wall Street bankers were all indoctrinated into that same perspective, what’s to say that Standard & Poor’s is not politically motivated?

    The GOP, rather cynically, wants to see Obama fail. That is the end; the means seems to be preventing or squandering our economic recovery. Because in the calculus of the right, a crashed economy will lose Obama the next presidency, and will mean the implementation down the road of a whole range of conservative social reforms that will fundamentally alter our society (effectively repealing the 20th century.) If you’re just waiting on the End Times anyway, a catastrophic economy is just another bump in the road.

  2. In the famous short story, “The Emperor’s New Clothes,” the King commissions a couple of con artist weavers to make him a set of clothes so unique that they would be “invisible to those unfit for their positions, stupid, or incompetent.”

    When we first read that story, even as children, we giggled out loud as to the unbelievable naivete of the King. And yet, as mature, “serious” adults we believe fairy tales even more incredible.

    We believe bankers would turn down mortgage requests from unqualified applicants even as their bonuses are contingent on the loans being approved, and their potential liabilities having been sold to the next “bigger fool.”

    We believe “independent” appraisers would perform due diligence in determining true value of real estate to which they’ve been assigned even as their continuing income is contingent upon those appraisals being whatever the banks want them to be.

    We believe regulators, performing their public service duties as society’s sentries, would diligently protect the public’s interests even as their much greater future incomes too often come in the employment of those they currently regulate.

    And we believe the Conservatives, who, when they held the Presidency the last two times plunged us into indebtedness the sum of all previous Presidents combined couldn’t equal, are the folks to follow now.

    The author of “Fool me once, shame on you……..” obviously wasn’t familiar with 21st. Century America. Donald Trump, who inherited his fathers successful, journeyman’s construction business and immediately plunged it into a 5 billion dollar bankruptcy began his comeback by writing a book, “The Art of the Deal.” Then, proving beyond doubt that America is inhabited by an overabundance of cognitively challenged, barely literate mouth breathers it shot to top of the NYT best seller list.

    Now, what was your question again?

  3. Brad deLong thinks the peculiar response of the markets – no rise in interest rates on US government debt, a fall in the Dow – indicates that professional investors on Wall Street also treat S&P’s move as a political move to spook Washington into a debt-reduction deal.

  4. None of this means that the S & P “finding” is irrelevant.

    Actually, that’s precisely what it means. When an entity has a proven lack of integrity then its predictions are fundamentally useless, even as a starting point.

    “Fibbers’ forecasts are worthless. Case after miserable case after bloody case we went through, I tell you, all of which had this moral. Not only that people who want a project will tend to make innacurate projections about the possible outcomes of that project, but about the futility of attempts to “shade” downward a fundamentally dishonest set of predictions. If you have doubts about the integrity of a forecaster, you can’t use their forecasts at all. Not even as a “starting point”. By the way, I would just love to get hold of a few of the quantitative numbers from documents prepared to support the war and give them a quick run through Benford’s Law.”

    http://d-squareddigest.blogspot.com/2004/05/d-squared-digest-one-minute-mba.html

  5. I pretty much agree with Zasloff, but have something to add.

    Rating agencies sometimes get bored with the business of rating default probabilities. They often think that they are regulators, or moralists, or something. This is especially true with governmental debt, but I’ve also seen them play regulator with straight corporate debt–which is supposed to be their bread-and-butter and strong point. (To the credit of the rating agencies, their straight corporate debt ratings haven’t embarrassed them recently.)

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