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Author 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 rating

Author 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 ago
FYI: 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 ago
I'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...
- mtoddh 15y ago
  Maybe I misinterpreted the article too, because an "excess of overcaution" sounds a lot like blame shifting to me, in this case from the rating agencies onto the investors who believed the ratings. The argument implies that because investors were "overcautious", and only willing to buy AAA rated securities, the rating agencies were therefore compelled to rate things AAA they otherwise would/should not have. At any rate, it seems that rating agencies should be rating things accurately regardless of how cautious investors are.
derrickpetzold 15y ago
jellicle is correct the ratings are complete bs. If AAA actually meant something the US would have been downgraded years ago. AAA means there is no chance of default no whatever so ever. It should only be reserved for countries with little or ideally no debt. The fact that our politicians and media are openly talking about default means that AAA does apply to the US but it does. So it means nothing.
- mynameishere 15y ago
  The (non-BS) default risk of the US is very close to nil. Hence the AAA is deserved. But the currency risk and the interest rate risk is very high. Here's the pair trade if you want it: http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=l&q=l&c=tlt http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=... ...notice that the 20 year treasury is more volatile than junk bonds.
  - kai-zer 15y ago
    You obviously don't understand the concept of duration. You are comparing 5-10yr debt to 20-30yr debt. More apt comparison would be intermediate treasuries, much different picture (time frame also questionable for a pure comparison): http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=l&q=l&c=ief http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=...
    - mynameishere 15y ago
      You can see some better numbers here. Of course, when I say "interest rate risk", that function involves duration. http://etfdb.com/etf/JNK/fundamentals/ http://etfdb.com/etf/JNK/fundamentals/ http://etfdb.com/etf/IEF/fundamentals/ http://etfdb.com/etf/IEF/fundamentals/
- RockyMcNuts 15y ago
  If a country has no debt, what security is being rated AAA?
  - 15y ago
anigbrowl 15y ago
Looking at the line graph, the % of total securities issues rated AAA, it's apparent that between 1991 and 1994 the proportion jumps up from ~20% to ~50% and then floats in a bracket between 50 and 60% for most of the next 2 decades. This obviously happened ahead of the dot com boom, and while I think you make many valid points, none of them address this startling change in the distribution of ratings. Unfortunately the chart only goes back to 1990, and I don't have time to dig up historical figures. Perhaps more financial instruments used to enjoy a AAA rating until the Savings & Loan scandal of the late 80s, and the sudden upward jump in ratings represents the purging of bad assets from the financial system following the recession of the early 90s. But really, I don't know. Without disputing your observations above, I think we could learn a lot from looking at the largest discontinuity here rather than focusing on the absolute volume figures from recent years, notwithstanding the significant increase in securitization following the repeal of Glass-Steagall.
- mdda 15y ago
  No - AAA was always meant to be the best of the best. Interestingly, there's now the question of whether the US debt should be rated AAA : Is there more than a 1-in-100 chance that the two sides can't get to some compromise (or, more likely, agree on how to kludge things) by September? AAA is meant to lead to default at a 1-in-10000 per annum rate (it's a standardized measure). So, by that argument, USA downgrade should have already occurred. And, since companies cannot be rated higher than the countries that they're in, that would lead to the immediate downgrade of Microsoft, etc...
  - count 15y ago
    Companies cannot be rated higher than the country they are in? I don't understand why that would make sense, especially in a case like the US - congress being unable to extend the debt ceiling shouldn't have that significant of an impact on Microsoft, a globally diversified company, being able to pay back it's debts...but then, the financial world is full of fun, arbitrary rules.
    - pkteison 15y ago
sp332 15y ago
He's saying that it's not the people who are receiving the investments who are driving up demand for AAA ratings, but the investors. People with lots of money aren't willing to take any risks, so they increase demand for AAA-rated investment opportunities. They will patronize ratings agencies that give them more AAA-rated options to invest in.
barrkel 15y ago
He said everything you said already, in the single phrase "regulatory arbitrage". He's covered debt for years, before he branched out into more broad finance coverage.
Confusion 15y ago
Only no one needs to be bribed. That's attributing malice where stupidity suffices. The 'shit' is so complicated the rating agencies actually think they are AAA and issue that rating without a bribe. The politicians have plenty of other reasons besides bribes to turn private debts into public debts.

onemoreact 15y ago

FYI: 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 ago

I'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...

mtoddh 15y ago
Maybe I misinterpreted the article too, because an "excess of overcaution" sounds a lot like blame shifting to me, in this case from the rating agencies onto the investors who believed the ratings. The argument implies that because investors were "overcautious", and only willing to buy AAA rated securities, the rating agencies were therefore compelled to rate things AAA they otherwise would/should not have. At any rate, it seems that rating agencies should be rating things accurately regardless of how cautious investors are.

derrickpetzold 15y ago

jellicle is correct the ratings are complete bs. If AAA actually meant something the US would have been downgraded years ago. AAA means there is no chance of default no whatever so ever. It should only be reserved for countries with little or ideally no debt. The fact that our politicians and media are openly talking about default means that AAA does apply to the US but it does. So it means nothing.

mynameishere 15y ago
The (non-BS) default risk of the US is very close to nil. Hence the AAA is deserved. But the currency risk and the interest rate risk is very high. Here's the pair trade if you want it: http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=l&q=l&c=tlt http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=... ...notice that the 20 year treasury is more volatile than junk bonds.
- kai-zer 15y ago
  You obviously don't understand the concept of duration. You are comparing 5-10yr debt to 20-30yr debt. More apt comparison would be intermediate treasuries, much different picture (time frame also questionable for a pure comparison): http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=l&q=l&c=ief http://finance.yahoo.com/q/bc?s=JNK&t=2y&l=on&z=...
  - mynameishere 15y ago
    You can see some better numbers here. Of course, when I say "interest rate risk", that function involves duration. http://etfdb.com/etf/JNK/fundamentals/ http://etfdb.com/etf/JNK/fundamentals/ http://etfdb.com/etf/IEF/fundamentals/ http://etfdb.com/etf/IEF/fundamentals/
RockyMcNuts 15y ago
If a country has no debt, what security is being rated AAA?
- 15y ago

anigbrowl 15y ago

Looking at the line graph, the % of total securities issues rated AAA, it's apparent that between 1991 and 1994 the proportion jumps up from ~20% to ~50% and then floats in a bracket between 50 and 60% for most of the next 2 decades. This obviously happened ahead of the dot com boom, and while I think you make many valid points, none of them address this startling change in the distribution of ratings. Unfortunately the chart only goes back to 1990, and I don't have time to dig up historical figures. Perhaps more financial instruments used to enjoy a AAA rating until the Savings & Loan scandal of the late 80s, and the sudden upward jump in ratings represents the purging of bad assets from the financial system following the recession of the early 90s. But really, I don't know. Without disputing your observations above, I think we could learn a lot from looking at the largest discontinuity here rather than focusing on the absolute volume figures from recent years, notwithstanding the significant increase in securitization following the repeal of Glass-Steagall.

mdda 15y ago
No - AAA was always meant to be the best of the best. Interestingly, there's now the question of whether the US debt should be rated AAA : Is there more than a 1-in-100 chance that the two sides can't get to some compromise (or, more likely, agree on how to kludge things) by September? AAA is meant to lead to default at a 1-in-10000 per annum rate (it's a standardized measure). So, by that argument, USA downgrade should have already occurred. And, since companies cannot be rated higher than the countries that they're in, that would lead to the immediate downgrade of Microsoft, etc...
- count 15y ago
  Companies cannot be rated higher than the country they are in? I don't understand why that would make sense, especially in a case like the US - congress being unable to extend the debt ceiling shouldn't have that significant of an impact on Microsoft, a globally diversified company, being able to pay back it's debts...but then, the financial world is full of fun, arbitrary rules.
  - pkteison 15y ago

sp332 15y ago

He's saying that it's not the people who are receiving the investments who are driving up demand for AAA ratings, but the investors. People with lots of money aren't willing to take any risks, so they increase demand for AAA-rated investment opportunities. They will patronize ratings agencies that give them more AAA-rated options to invest in.

barrkel 15y ago

He said everything you said already, in the single phrase "regulatory arbitrage". He's covered debt for years, before he branched out into more broad finance coverage.

Confusion 15y ago

Only no one needs to be bribed. That's attributing malice where stupidity suffices. The 'shit' is so complicated the rating agencies actually think they are AAA and issue that rating without a bribe. The politicians have plenty of other reasons besides bribes to turn private debts into public debts.