10 ms·
The horrifying AAA debt-issuance chart
- phillmv 15y agoI wonder; is it not increasingly obvious that rating agencies are fraudulent by nature/rent-seekers writ large?
- positr0n 15y agoWhy do you say that? I'm not saying you're wrong I'm just genuinely curious since I don't know much about the subject.
- orofino 15y agoAs the article states and as we found in the recession, there can't possibly be this many AAA rated organizations. I'll give an example at the risk of my memory failing and there being a difference in which exact organization it was: Days before they went bust, GMAC bonds were still AAA rated.
- VladRussian 15y agoi guess people either understand "grading on the curve" or not :) Anyway, seems to be a business opportunity to start issue ratings for AAA papers, as obviously there is a lot of junk AAA out there.
- orofino 15y agoThe documentary "Inside Job" covers why and how the "grading on a curve" happened. I'd recommend it if you're at all interested in this stuff.
- prostoalex 15y agoAren't most corporate bonds insured by a third party?
- justincormack 15y agoNo that is not generally the case.
- justincormack 15y agoAlso, just the amount of issuance will in itself increase the risk, as interest payments are higher.
- orofino 15y agoI don't believe that this inherently true. The market generally revoles around risk, additional returns are possible when taking more risk. Higher rates of issuance just mean that there is more availability and possibly drive the prices down due to supply. Now, a lower rating would result in a hirer interest, as lower ratings means higher risk (at least in theory, but what this article actually shows is that this isn't the case).
- justincormack 15y agoHigher issuance means that the company has higher leverage, which means higher risk. This should of course cut ratings, but might not.
- gtani 15y agoI believe that until about 1995 there were fewer than 5 bond issuers subject to Chapter 11 proceedings (strategic bankruptcies) that were AAA at the time of the Chapter 11 filing: Texaco and, I think, Manville the asbestos maker. There was also one AAA muni bond that defaulted. There were several cases where issuers like Lilco (Long Island Lighting) were rapidly downgraded from AAA to junk.
- tptacek 15y agoMaybe, but BRK and the US Treasury are meaningfully AAA. There is clearly a class of AAA risk that means something, and a (far larger) lower tier of AAA risk that merely rides the coattails.
- ChuckMcM 15y agoGuess we'll know whether or not US Treasuries are meaningfully AAA in the next couple of weeks :-)
- phillmv 15y agoRight. I think that overall that's correct - for all intents and purposes it's effectively impossible for the US Treasury to run out of dollars. But the way the incentives for agencies are set up makes me think we're begging to be lied to. Mind you, despite all this you can have a serious news piece of "someone from Moody's" claiming that they might be forced to lower the US' rating http://www.bbc.co.uk/news/business-14142621 http://www.bbc.co.uk/news/business-14142621 - which frankly just sounds all kinds of ridiculous.
- mdda 15y agoWhy ridiculous? The treasury cannot, by law, issue more than a certain amount of debt. The politicians may change the law - but that's a vote that's yet to have been taken. Once upon a time, it would have been unthinkable for Japan to have had a lower credit rating than AAA. Also, the US owes money in currencies other than $, which the Treasury doesn't have the power to print.
- deleted 15y ago[deleted]
- Someone 15y agoThe US Treasury is not, by definition, AAA. It can print money at will, but it cannot guarantee that that money will have value.
- gaius 15y agoThere's nothing rent-seeking about it; anyone can start a ratings agency. All Moody's et al have is what we would now call "mindshare" . It's no more rent seeking than say the Met Office having a monopoly on weather forecasting...
- pessimizer 15y agoIt's more than mindshare, it's also the fact that the ratings given by NRSROs ( http://en.wikipedia.org/wiki/Nationally_Recognized_Statistical_Rating_Organization http://en.wikipedia.org/wiki/Nationally_Recognized_Statistic... ) are often written into statutes. There are many massive funds that are restricted by legislation from investing money somewhere that Moody's has rated at lower than X, X often being AAA.
- JamisonM 15y agoThe author argues that AAA debt is dangerous because it breeds complacency because it is considered risk-free. It strikes me that this is begging the question of how all these debt instruments can carry the same grade and do so so consistently. Is it not the case that AAA debt is dangerous because most of it is probably not really AAA? I thought we established a long time ago that the ratings system is broken, this is just another symptom of that illness that no one is willing to even try to cure.
- tptacek 15y agoThat's his point. There is no conceivable way that even a large fraction of that debt is AAA. What instead appears to be happening is a vicious circle: * The finance industry engineers new ways to massage riskier debt into AAA products * The market eagerly devours all the new AAA debt, building new business models and expanding previous ones based on the increased availability of risk-free products, thus * Sparking demand for more AAA debt.
- orofino 15y agoIt isn't clear to me why AAA rated bonds represent such systemic risk, the article says the following: "They breed complacency and regulatory arbitrage, and they are a key ingredient in the cause of all big crises, which is leverage." Is the author arguing that these should all just be rated below AAA and as such be accompanied with higher interest rates? This would obviously depress the rate of issuance because companies would be less inclined to take the terms (at least in theory). This makes sense to me, but doesn't necessarily indicate that AAA rated bonds inherently have systemic risk as the author states. Perhaps I'll read the article a second time through.
- tptacek 15y agoFrom the article: Then look at the green line. Triple-A debt wasn’t a huge part of the bond market back in the early 90s, but for the past decade it has invariably accounted for somewhere between 50% and 60% of total global fixed income issuance. That’s possibly the most horrifying bit of all: it simply defies credulity for anybody to be asked to believe that more than half the bonds issued in any given year are essentially free of any credit risk. That seems like the nut. It's prima facie obvious that much of what is called AAA can't be AAA; it almost mathematically beggars the definition of AAA. Meanwhile, all kinds of contracts, regulations, and instruments rely on AAA ratings to prevent money that can't reasonably be put at risk from going into e.g. mortgage bonds.
- orofino 15y agoThen I'm inclined to disagree at another portion of the post which seems somewhat contradictory to the point: "it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution" The greed then exists in alternate areas of the system. It isn't AAA bonds that are the issue, it is the fact that lesser bonds are being rated as AAA. Why are they being rated that way? The ratings companies have conflicts of interest and were... (wait for it) greedy. In addition, calling this an "excess of overcaution" is laughable, if I can get decent returns from a "risk free" investment, that isn't cautious, it is logical.
- 15y ago
- ars 15y agoYet another non logarithmic graph of money, sigh. When will people learn.
- samstokes 15y agoThis sounds like an interesting insight. Could you elaborate?
- ars 15y agoCompare the difference between 1000 and 2000, vs 4000 and 8000. In both cases it's double, but in the second case the difference appears to be 4 times as large. This graph is linear, so it makes it look like the jump from 4000 to 8000 is more significant than the jump from 1000 to 2000, but actually it's not. It's identical.
- Andrew_Quentin 15y agoHow is it identical? One has a difference of 1000 the other of 4000. We all know that $4000 is much more than $1000. The only thing they have in common is that both amounts have doubled, but I think there is a huge difference between 1000 to 2000 with 1 million to 2 million although they both have only doubled.
- ars 15y agoNo, actually. With money the only thing that matters is the degree of change, not the simple number. The change from 1 million to 2 million is much more important than the change from 99 million to 100 million. Try an experiment: take a calculator or a spreadsheet. In one case start with 1000 then keep doubling it. In the other start with 1 million and keep adding 1 million.
- ipsin 15y agoI think the idea is simply that, since inflation is a compounding process, given a constant rate of inflation prices will form an exponential graph. A log scale would let you see more detail in the 90s, but in this case I think I actually prefer the linear, 0-anchored version.
- glhaynes 15y agoIn what way do AAA-rated products "breed ... regulatory arbitrage." What does that mean?
- rgraham 15y agoSee tptacek on this thread: http://news.ycombinator.com/item?id=2768921 http://news.ycombinator.com/item?id=2768921 A lot of regulation tells big often state-based institutional investors like retirement plans and university funds that they have to invest X% in AAA rated investments. Demand for AAA rated products creates not just financial wizardry that spawns more AAA products from riskier products, but the increasingly powerful finance industry/lobbyists pressure government officials (usually appointed representatives from the finance industry) to make this easier...if not transparent.
- samstokes 15y agoI assumed it meant something like a corporation using regulatory loopholes to get their bonds rated as risk-free (and thus desirable to own) when they would more accurately have been rated risky. Put more simply, borrowing money more cheaply than their creditworthiness should allow. His point was about the prevalence of AAA-rated products, not their existence.
- jellicle 15y agoAuthor doesn't really understand the situation. The problem, which started becoming visible in 2001, is that in the aftermath of the "dot-com boom", the ratings agencies starting rating a lot of things AAA that were not, in fact, AAA. That is not "an excess of overcaution". In fact it was an exploit of the banking/finance system, that went like this: -- lots of places are required by law or regulation to only invest in AAA securities, because they/the public don't want to lose any money. They have a LOT of money to invest. -- but they don't check the shit themselves -- they depend on a rating agency -- ratings agencies are paid by the issuers -- they are exploitable -- bribe the rating agency to give my shit a AAA rating, and now I can sell a ton of it -- offer the investor a slightly greater than AAA return, and they love it -- everyone is happy: rating agency is bribed, investor is getting better returns than expected, and I can sell all the shit I can package up -- until it all falls apart. And the far right side of the chart is just a continuance of the same thing: our shit fell apart, what should we do? Well, the easiest thing is to bribe the politicians to take our private debts and turn them into public debts. And so it happened. That big tall lavender bar in 2009 is the dark purple lines from a few years prior.... None of this has anything to do with an excess of caution or with AAA debt being more systemically dangerous than other types of debt. The blogger here almost grasps what is wrong: > "That’s possibly the most horrifying bit of all: it simply defies credulity for anybody to be asked to believe that more than half the bonds issued in any given year are essentially free of any credit risk." but he skips past the correct answer, which is that the ratings agencies have been suborned.
- onemoreact 15y agoFYI: using long quotes tends to break page formating on HN. If you not directly quoting something it's best not indent things or to manually break up the lines.
- mcphilip 15y agoI'm quite certain Felix Salmon understands everything you mentioned, but apparently since he didn't dress the issue in the way you simplify it, it means he doesn't understand the situation. Maybe do a search on his blog for ratings and try glancing through some of the (hundreds) of posts he's written in the past few years before making your judgment? Specifically, you're misinterpreting what is meant by "an excess of overcaution". Felix is referring to how investor demand being too cautious (i.e. only interested in or able to invest in AAA) lead to a scenario where all sorts of tricks were developed to get an AAA rating on securities [1]. 1. http://blogs.reuters.com/felix-salmon/2009/08/26/shrinking-banks/ http://blogs.reuters.com/felix-salmon/2009/08/26/shrinking-b...
- rexf 15y agoAn example of why not all AAA debt is truly AAA grade: "As it turned out, triple-A-rated mortgage bonds stuffed with bad subprime mortgages were considered very low risk" Source: http://www.nytimes.com/2011/07/10/magazine/sheila-bairs-exit-interview.html?partner=rss&emc=rss&pagewanted=all http://www.nytimes.com/2011/07/10/magazine/sheila-bairs-exit...
- shareme 15y agoSome items to keep in mind: 1. War on Terror and TARP are large portion of the current USA deficit, probably 80% or higher. 2. Over-issuance of AAA ratings will come back to bite as it has to be rolled-over at some point. 3. TARP spending direct result of not controlling the security class known as derivatives ...precedent last time we had to assert Federal control to correct market excesses in securities as 1929-1930 with the SEC act. IN other words we could force security exchanges to outlaw derivatives to bring order/stability back but anyone receiving bank lobby money will not broach that subject.
- kai-zer 15y agoFalse... TARP is expect to cost the taxpayers, $25 billion. A small price to pay to avert total financial ruin. http://cbo.gov/doc.cfm?index=11980&zzz=41404 http://cbo.gov/doc.cfm?index=11980&zzz=41404
- anonymoushn 15y agoIf you give me a loan, then as it expires I take out a new loan to pay you back, would you say that you've made money from the arrangement? I would say that you haven't, as if I default the second loan you still take a net loss across all our transactions. However in the case of TARP, many TARP loans were rolled over into non-TARP loans, without the principal being returned at all. We could also discuss whether it is a good idea to subsidize the losses of some parts of the financial and automotive industries but not others, whether this is really conducive to a healthy economy based on competition, and whether the incentive structure created by handing bags of stolen money to anyone who can credibly threaten to damage the economy is a good one, but this probably isn't the place to do it.
- deleted 15y ago[deleted]
- Andrew_Quentin 15y agoThat is quite curious because we never had any deficit reduction debate before 2007 or any talk about government having too much debt yet now we all the sudden do. I think if there was a graph of government debt it would show a big spike around 2008.
- jleader 15y agoSaying "AAA bonds will cause a crisis" is like saying "Homeowners' mortgages caused the mortgage crisis". They're an essential part of the situation, but the actual cause was the misrepresentation of the riskiness of the securities, due to capture of the rating agencies by their customers, the securities issuers. Is there a term analogous to "regulatory capture", for capture of non-government organizations like rating agencies by the subjects of their ratings?
- zipdog 15y agoIf contracts and regulations require AAA-rated securities, then AAA-rated securities will appear to match the demand. As the author rightly points out: we have too many groups requiring AAA-rated securities and not enough real AAA stuff to go around, so most of the AAA ratings are going to be unreliable.
- mtoddh 15y agoIf contracts and regulations require AAA-rated securities, then AAA-rated securities will appear to match the demand. I believe that this is what is happening, but the argument that demand for AAA securities by overcautious investors is the root of the issue makes it sound like all of our problems could have been avoided by curtailing the demand itself- in this case, by encouraging investors to take on more risk (don't be overcautious!) and be willing to purchase lower-quality securities. As an investor, shouldn't I be able to choose what level of risk I'm willing to accept? And isn't it the job of rating agencies to provide accurate information so I that I can make an informed decision as to the level of risk I'm taking?
- chopsueyar 15y agoIt is either fear or greed.
- BenoitEssiambre 15y agoThis seems relevant: http://www.youtube.com/watch?v=7GSXbgfKFWg http://www.youtube.com/watch?v=7GSXbgfKFWg
- hollerith 15y agoIf everyone switched from buying 6-month Treasuries to buying 3-month Treasuries, debt issuance by the U.S. Treasury would double in one year, so there is not enough information in the article to merit an "Oh no," but I guess the OP had a deadline to meet.
- njloof 15y agoNaked Capitalism weighs in on this article as well: http://www.nakedcapitalism.com/2011/07/felix-salmon-misreads-aaa-bond-demand-to-say-overcaution-caused-crisis.html http://www.nakedcapitalism.com/2011/07/felix-salmon-misreads...