Martin Kettle: markets as messenger

Martin Kettle really does seem to have firmly grasped the shitty end of the stick in this argument:

Moody\’s believes? Who, pray, elected Moody\’s? Which treaty did Moody\’s sign? On what basis do we bow the knee to Ms Muehlbronner? I have nothing against her; but I do have something very strongly against the salience and influence of the credit ratings culture in which she is a rising spear-carrier. That\’s because, as the nations of the world struggle to extricate themselves from the global financial crash, Moody\’s and its two main competitors, Standard & Poor\’s and Fitch, are not objective neutrals whose only concern is to make intelligent oversight of the markets.

The thing is, you see, you don\’t have to bend the knee to Ms. Muehlbronner. You can go off and buy whatever bond you like, sovereign or not, whenever you wish. There is absolutely nothing at all stopping you from entirely disregarding any and everything she says.

At root though Kettle\’s problem is that he just can\’t deal with the fact that a market is simply the aggregation of the views of all the people in said market (and, indeed, those whose view is not to join said market). This is actually democracy writ large in the price system.

Ratings agencies are really, and they came into being long before the theoretical analysis was done, a response to George Ackerloff\’s asymmetrical information idea (\”the market for lemons\”).

Governments know more about economic activity, about tax revenues, about the laws they\’re going to pass, than individual bond investors do. There is thus an information asymmetry here. Markets with such asymmetries work less well than markets without such imbalances. And as so often happens, markets do find a way to reduce such asymmetries: Glass\’ Guide for used cars, ratings agencies for bond issues.

No, certainly, no one thinks that they are infallible and further, there are some imbalances in the way the market for their information works (for example, issuers pay the ratings agencies). But they are a response to that very problem that the market itself has noted.

We don\’t know, as individuals, what the Greek Government is doing to cook its books. So, collectively, we\’ll hire some bright people to go look at how the Greek Government is cooking its books. We can take their advice (\”we think they\’re going to go Kablooie!\”) or not as we wish. But we\’re not bowing to them, we\’re not ruled by them: they\’re simply an expression of opinion, one among others, in that marketplace.

But Kettle\’s real problem here is that he\’s reifying the market. \”The market\” causes this or that. It\’s not an unusual lefty thing to do, this reification. But it is, at root, still a gross error. For what is actually happening is that individual differences of opinion are being weighed off against each other and a general balance of what those opinions are is being reached.

The ratings agencies are only one set of such opinions: perhaps better informed (or suffering from perverse incentives if you like) than some others but that really is all they are.

If I think that the Greek Government is bust then I\’ll not buy their bonds (or sell those I own, sell those I don\’t own) and the more people think the way I do the higher the yield, the lower the price, of those Greek Government bonds.

The credit ratings agencies are leading a market assault on nations and peoples. We must curb them hard if we can.

It\’s lovely, isn\’t it? The instinctive response of banning free speech when you don\’t like what is being said?

13 thoughts on “Martin Kettle: markets as messenger”

  1. Actually I think both of you are wrong. The Moodys ratings have power not just because they are useful information which you can use or not but because governments have decreed at various times that you need to have a particular rated instrument for various purposes and the rating comes from one of a small number of firms which are regulated by the government. Also some funds say in the prospectus that they will only invest in instruments of a certain rating.

    So it is mainly governments that have changed a useful source of information into a pseudo-regulator which then distorted the information they provided as it came much more important to game it.

  2. It’s amazing that people can get so high-flown language going about the possibility that financial markets will refuse to lend any more money to some sovereign nations. Capitalism gets it both ways in this analysis, if financial markets aren’t wrecking the world economy by lending money to people who probably can’t repay it, they’re wrecking the world economy by not lending money to people who probably can’t repay it.

  3. The ratings agencies are basically offering an editorial service: their considered opinion on something. Rather like the Guardian offers its paying readers.

    If we regulate ratings agencies as an “assault on democracy” I suggest we tie Kettle in knots for regularly assaulting democracy with his ill-informed opinions.

  4. “This is actually democracy writ large in the price system.”

    It’s also a daily democracy: every hour of every day, opinions are being canvassed and people are backing up their opinions by putting cash on the line.

    That’s way more democracy than some people are prepared to stomach.

  5. And iron law of articles is if the writer says ‘pray’ it’s going to be nonsense. AG is write, govts. unfortunately elected the ratings agencies .

  6. The Man Without Fear

    I agree with your analysis about the information function of ratings agencies. However, this does seem to ignore the point that these ratings agencies aren’t immune from political or commercial interference and that they therefore can be considered to be partial commercial entities (rather than impartial information-aggregating entities).

  7. “This is actually democracy writ large in the price system.”

    Correct, but perhaps not in the way you meant it. As AG points out, governments (including our own) have turned the ratings agencies into effective regulators of the bond market, and this has created a number of distortions, such as the exaggerated price difference between AAA and AA+, and the market for CDS, both of which have played a role in our financial troubles.

    I would reverse the final quote, and say that the credit agencies are leading a popular assault on markets. We ought to return them to their rightful, valuable place as providers of information.

  8. Salem – AG was right, but not as bond market regulators.

    That the rating in itself generates a premium is no different from from say the FTSE100 index effects on equities. A good rating has value. This is what is supposed to happen.

    If people find a mechanism effective they will buy into it, literally.

    The problem was when ratings were used not as information but as a regulatory stamp of approval. The stamp becomes more important than the quality of the rating process itself.

    Even if it were obvious to all a rating was awarded purely on a technicality, it would still be a valuable as a regulatory stamp of approval.

    The market for lemons was re-invented in the rating market itself. Result: excess risk and a bigger bubble.

  9. Remember that rating agencies’ scores are even used by the regulators when they look at the credit risks on the balance sheets of banks, under the Basel capital rules system.

    S&P, Moody’s, Fitch and the rest, such as credit scoring firms, do have a degree of favoured status conferred by government rules.

    Skeptics will, of course, point out how the agencies signed off on a lot of dodgy CDOs that were packed with sub-prime rubbish, or failed to be alert to the 1997 Asian crash (remember that?), etc. These guys are fallible; useful, but still fallible.

  10. “That the rating in itself generates a premium is no different from from say the FTSE100 index effects on equities. A good rating has value. This is what is supposed to happen.”

    My point is not that the rating generates a premium, which would indeed happen in a free market, but that the regulatory agencies’ demands on investors make the premium higher than it would otherwise be – i.e. an “exaggerated price difference.” I do not think we are in disagreement.

  11. Johnathan Pearce is right (ye Gods!). The ratings agencies have made a lot of mistakes. In a better world they would have been the subject of class actions for giving triple A ratings to sub-prime derivatives and ,not incidentally , wrecking the world economy. It is ludicrous that silly out-of- their- depth people like Cameron and Osborne should be declaring class war on their own people to propitiate these fallible people who have too much power.
    Tim is,as usual, giving expression to his romantic quasi- Gaian imagination when he sees the market economy as some vast self -regulating system of equal parts ignoring the decisive presence of monopolists, despots and dictators at key points .His vision is no different in kind from those who used to condone the actions of Communist leaders because they claimed to channel” the will of the people” (in aggregate).

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