AAA Dilemma: What if the Ratings Agencies Disappeared?

In general, there’s a conflict with the ratings agencies because they are a bit of a proxy regulator, given power through the federal government to rate bonds and other financial instruments, and so many other bodies can’t invest their money in a financial instrument unless it has a certain rating from certain ratings agencies. Moody’s, S&P, and to a lesser extent Fitch have a stranglehold on the system because they’re written into law and there are high barriers to entry to starting a new rating agency. Anyways, there is the conflict because they exist in a market, but the companies that they rate pay them. 

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So there is this question about how independent the ratings are, since if they don’t get the rating, they like from one agency, they can just walk down the street to another. And then there is the prestige issue, where the people packaging financial instruments have more power because they work at Goldman and make multiples of what someone at a ratings agency does. Overall, I think this relationship had a big effect in the run up to the financial crisis because the CDOs were being rated AAA for even their riskiest tranches because there was a fundamental lack of underwriting going on and the ratings agencies were not ready to push back against these banks to say that you’re selling people trash that will blow up. Of course being real close to the day to day activity, you really don’t have the perspective to say that this will be one of the things that makes the whole house of cards fall down, but at least you can say that the credit on these mortgages is too bad, and you’re not taking in account correlation risks, and there is a chance that house prices may go down. The riskiest 5% of these are not as good as treasuries.

Thinking if the ratings agencies went away for some reason, the first thought is to say good riddance. But the second thought is that there is a lack of information in the marketplace by not having these quasi-independent bodies, overall it would drive up costs in the market and make borrowing more expensive for everyone. What it would more likely would do is make a mirror of the equity market. The larger companies would get independent research done, so Disney and US Steel could issue bonds, but for smaller and less liquid offerings, that is where costs would go up the most – bifurcation the market so that the rich got richer. Hopefully the state would step in to offer truly independent ratings until that agency got captured.

The Market: A Positive Sum Game

When financial markets channel funds from savers to investors, who benefits?

The simple answer to that question is that everyone benefits when financial markets channel funds from savers to investors. The saver, who might have very few options about where to put her money – in the book the author jokes about putting it under the mattress – with a functioning financial system can achieve greater return on her money. The investor wins because they now have capital. Having an idea to make or do something novel to fill a niche in a marketplace is worthless unless you have capital to invest. With a healthy financial market, you can go and get funds to facilitate your new idea that helps you undercut the local taxi market or local hotel market. Your idea can come to fruition when previously you had top hope to be individually wealthy or have the right connections.

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 But there’s more! By facilitating that transaction, where the savers and the borrowers benefit, it is not isolated to those parties. Society benefits, as there is now the thing that was not existing in our alternate world without good financial markets. You have Uber instead of calling a cab and hoping that their credit card machine isn’t “broken”, and they are ok with driving you to your neighborhood at that time of night.

And then, for their efforts, the financial market makers get a nice little sliver of the action to reward them for their coordination efforts. Just a little though.

Inaugural Address

One of the best things about our democracy is that at the local level, we can all have a voice that we might not feel we have when we think of the people we send to Washington to make policy, no matter what side you feel yourself rooting for.

The flip side of local control is that many people let others chose for them - who runs and who votes. In Brookfield, there are about 19,000 people. The Village Board was contested, but of the 13,269 people registered to vote, only 2,716 cast ballots in the election. My name was down the ballot, but enough of you chose me to serve that I now have the opportunity to do so.

Today I was sworn in as the newest member of the Brookfield Library Board of Trustees. I’m glad I have the opportunity to serve, and I hope that my experience and education allows me to fully represent not just the 1,936 people who checked the box by my name or everyone who voted - but all 19.000 of us. I will be the best steward of your tax dollars that I can be, and will help make Brookfield Brighter for the 21st century.

Against Teleology: New Social Orders are Built Brick by Brick

In a class recently, we had a discussion on the stagist theory of growth that was supposed to be answered several weeks in the future. I went early to the message board and posted that “Human civilization has manifested itself in a series of organizational structures, each determined by its primary mode of production, particularly the division of labor that dominates in each stage. 1) the tribal form, 2) primitive communism, 3) feudal or estate property, 4) capitalism”. I posted this without citing Marx, and it was mostly done in jest. When I posted it, I was unaware of the Rostow model of growth theory, where we move from traditional society to “the preconditions for take-off” to take-off to modernity where the economy is mature, and the people are mass consuming (Cypher 189-192).

What the Marxian framework and the Rostow model share is that, as Cypher notes, they are an attempt at a universalist model of development (187). So, if you follow either of them, then all societies must pass through these stages. If you subscribe to either one of these fully, then you social and economic prescriptions become based on moving the country of interest through these stages. My thinking on this goes to arguments in the late nineteenth century about the possibilities of the development of a communist state. The argument was that it was the most Capitalists states that would move to the next inevitable step first. This led people to think that it would be England and Germany that would be the first homes of the universal brotherhood of the worker’s state. And well, we can see that the lens of history disproved that, as it was the giant Russian state that was levered into the international vanguard as the first communist state. There was a big problem with this in terms of Marx’s theory of stages in that Tsarist Russia was agrarian, so that one of the first things that had to be done for the new Soviet Union was to industrialize it. The fact that they did industrialize as much as they did in the years prior to the Great Patriotic War is a feather in the cap of the Soviet system and its leadership (though at much human cost).

The problem with both Marx’s outline and Rostow’s is that it tries to universalize experience based on a narrow understanding of how the world works through limited history (Cypher 187). A too-narrow understanding of how history can develop leaves all other possibilities on the outside looking in. If we want to say that all nations must move through these stages and then the only logical endpoint is the last of the numbered states, it limits the possibilities of what growth and development can look like. It takes the path dependency that we created for ourselves and maps it upon another set of people. Though there have been benefits to our mode of take-off and modernization, there have been social and environmental costs that we do not necessarily have to grant to people in the name of development. Both models are well in parallel, with Rostow adding finer graduation, but they have the same end point, a developed world (Marx just wants to see a different set of people own the capital). 

Works Cited

Cypher, J. M. (2014). The process of economic development. London: Routledge, Taylor & Francis Group.