Credit Agencies

[Walsingham]

Article

 

 

If i may condense the point made, it is that by being slow to respond CRAs exacerbate the boom and bust cycle. The pump bad credit risks, and chase those who are failing. This is interesting enough, to the terminally boring like myself. But I had a further thought.

 

Everyday normal people are subject to almost identical CRAs, except being mass market they are even less accurate. I can say this, having worked for both banks and CRAs in the past.

 

Now, surely if the faults outlined in the article are true then they are probably true for people. A graduate student will be rated as a less good risk than a 40 year old manager, but if anything the manager is far mroe likely to have hidden debts, be on the berge of a psychological breakdown, about to undergo divorec and loss of assets, be made redundant and long term unemployed etc etc.

 

Thoughts?

[Moose]

I hope that's not your life at 40.

[Wrath of Dagon]

This is not really news, just a new example. It's well established that the rating agencies were a large part of the reason for the financial crisis. Conflicts of interest were involved, as may be expected. The individual example doesn't really work though, the credit rating is based on past history. Anything is possible of course, but it's all about probabilities.

[Monte Carlo]

If you are asking someone to lend you money, you represent a risk to the lender. The lender has every right to mitigate that risk, mainly by checking your ability to pay and using analysis to gauge terms and conditions. This is why Frau Merkel is being a bit sniffy about Greece, and who could blame her? She wasn't in the chair when the EU fudged Greek entry into the Euro.

 

The problem kicks in when some smart-arse decides to bundle debt into a commodity and sell it, I'm not a financial expert nor economist but even I can see that's a bad idea.

 

As for risk around the relative age of the borrower - it's a no brainer. In the UK the 40-something has more chance of having an asset that can be secured against the loan - namely his or her house and the equity in it. The 20-something probably has five pot-noodles, an i-phone and a pair of skinny jeans to his name.

[thepixiesrock]

Yeah I mean, one of the things you learn early on in economics is that it's riddled with "self fulfilling prophecies" and I agree. CRA's probably do make the problems of the economy worse. The guy who wrote this article seems to want to get rid of credit rating all together, and I mean, on a micro scale maybe that's fine, but on a macro scale I'm not sure how that would work. I feel like we need it but there's just a lot of room for improvement. Like with this whole housing market crisis we had that he mentions for example. Yeah they screwed up and didn't really understand what they were rating. So when mortgages that had AAA ratings were defaulting, you knew there was a problem with the ratings. I'm not sure not having ratings at all would have helped though. Like, would the people who invest in whatever they are investing in have to research it themselves? I mean in most cases there isn't time for that.

 

I mean, this whole housing thing is just one instance, and I don't really blame the CRA's entirely for the bad ratings. Nobody really knew what was going on in the housing bubble, and I'm not sure how not having ratings would help the system.

 

 

As for your specific case Wals, I mean yeah I assume a person's rating would be placed purely on a buyer/business history or whatever if we're talking in terms of a loans or investiment into the person as a company or something, and like, those other factors such as health and personal relationships affect the person, but there isn't a reliable way to measure that, so the CRA's can only really stick to factors they can reliably measure obviously. I mean, I'm just not sure that mental breakdowns and divorce and what not represent a significant enough problem to cause them to take that into account when rating people, on a large scale.

 

Like, let's assume the grad student and the manager each want to open a business, so they ask for a loan. I'm sure their rating would be based on if they are making money now and how much, what their past credit history would look like, how long they've been working, and what not. Like, I would think that the thinking behind it would be that the 40 year old manager is less of a risk just from life experience assuming all the other points of his background are in good standing. So like, if something did happen to him, based on his history, he would be able to handle it better than the grad student just because the grad student wouldn't have the same experience in the working world. Like, the grad student could suffer any number of unknown non-business related problems. Any number of health risks or relationship hazards (we've all been there) or whatever, and not know how to handle it, or he might. The point being that there isn't a reliable way to measure those unknowns. I don't really think that's reason to throw out the rating system

 

Also what that guy up there said about assets. I'm a big dumb idiot.

Edited April 28, 2010 by thepixiesrock

[Wrath of Dagon]

Not to rub salt into the wound, but here's an interesting article: http://blogs.the-american-interest.com/wrm...rope-in-crisis/

[Walsingham]

My view is merely that bad intelligence is worse than no intelligence, because bad intelligence causes you to take unwise risks. Whereas a lack of intel has at least the virtue of inspiring caution.

 

I accept that good financial prediction of debt management is difficult. But where billions of pounds are at stake I expect difficult to be a superable challenge.

 

@Monte: If acquiring debt can be a good investment in the first place is bad I don't see why buying it could possibly be bad. Buying crappy debt is bad. Buying good debt cheaply is a damn good idea.

[Enoch]

If run well and kept independent, credit agencies (both for securities and for individuals) serve a useful role. When you're considering contracting with a party, you need information about their assets, liabilities, trustworthiness, etc. That's a transaction cost. A rating agency presents a more efficient way to do elements of that research than having separate investigations by each and every party that might be associated with an entity. The transaction costs are reduced, which is a good thing for all involved.

 

One of the big problems with financial markets during the boom years is that the major ratings agencies were also working as consultants for most of the firms that underwrote the now-toxic securities. So the people who were doing the ratings were under institutional pressure to not anger the issuers, and thus used models that generally understated the risks.

 

Work needs to be done to prevent this kind of conflict of interest, but we don't want to toss out the efficiency gains that ratings agencies can provide, either.

[Humodour]

Article

 

 

If i may condense the point made, it is that by being slow to respond CRAs exacerbate the boom and bust cycle. The pump bad credit risks, and chase those who are failing. This is interesting enough, to the terminally boring like myself. But I had a further thought.

 

Everyday normal people are subject to almost identical CRAs, except being mass market they are even less accurate. I can say this, having worked for both banks and CRAs in the past.

 

Now, surely if the faults outlined in the article are true then they are probably true for people. A graduate student will be rated as a less good risk than a 40 year old manager, but if anything the manager is far mroe likely to have hidden debts, be on the berge of a psychological breakdown, about to undergo divorec and loss of assets, be made redundant and long term unemployed etc etc.

 

Thoughts?

 

What alternative is there though?

[Walsingham]

As I see there are two options:

 

1. Do credit rating properly, not based solely on past history and current surface circumstance. It has occurred to me that the insurance industry has begun learning this lesson since Hurricane Katrina.

 

2. Accept that credit ratings are very far from imperfect and move to a highly risk averse model. To prevent testosterone addled halfwits getting out of hand, legislate supervision and transparency in the assessment process right down to the base assumptions.