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Posted By on December 20, 2008

Robert Waldman has an article on Angry Bear on the credit rating agencies – The Tragedy of the Ratings.

The synopsis is that S&P sold out because they weren’t paid enough.

What went wrong with the ratings agencies ?

I think the central problem is that the ratings agencies long provided a service of immense value to society, and were paid a tiny fraction of that value to do so. The loss of credibility of the ratings is one of the causes of a terrible recession. This loss is more likely to cost the world trillions in lost output than mere hundreds of billions. Sure seems that the credibility of the ratings agencies was worth, at least, hundreds of billions to the world economy. That dwarfs the market capitalization of the ratings agencies.

We lost that because we collectively decided to take it from them rather than paying them what their credible ratings were worth. For decades they provided messages of one to three letters which were collectively worth hundreds of billions per year. They were paid their costs plus a normal profit margin, just as if it wasn’t a miracle that so much value could be created with so little effort.

Waldman is badly wrong here. Here’s why:

Any project that requires multiple actors, or multiple inputs, fails if any one of them is missing.

For example, New York City depends on its janitors to take out the trash, and clean up its buildings, after everyone else has gone home for the night.

If those janitors stopped doing their job, or did it very badly, Manhattan’s office towers would quickly become uninhabitable, costing the city hundreds of millions, or perhaps billions of dollars.

By Waldmann’s logic, janitors’ contribution is therefore worth the economic output of NYC – because without them, the city doesn’t work.

Any complicated system requires the contribution of many different parts for the system to function as a whole.  That doesn’t mean that the lug nuts that hold your wheels on deserve the credit for your car.

The media makes the same stupid mistake when they randomly give the credit – or the blame – for the result of some election to one specific group.  Mormons, (CA) for example, or blacks, or “soccer moms,” or gay Latino bartenders between the ages of 24 and 33.  Or whatever.

In any close election, any group, of sufficient size, is to blame as much as any other group, if you don’t like what happened.  (Or deserves the credit, if you do.)  Picking one in particular… is arbitrary.

On a side note, I don’t understand why anybody ever trusted S&P in the first place.

I mean, I don’t buy a TV, based on ratings paid for by Toshiba.

Why anyone would buy a few hundred million dollars worth of bonds based on rating paid for by the company selling the bonds is beyond me.

Hasn’t Wall Street ever heard of Consumer Reports?


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