Gorton’s triple-A error

By Felix Salmon
March 22, 2010
official paper for the US Financial Crisis Inquiry Commission. Here they are, in situ:

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Beware of academics wielding exclamation marks!! Gary Gorton is a very highly respected professor in the fields of finance and economics, but that doesn’t stop him throwing double-shrieks into his official paper for the US Financial Crisis Inquiry Commission. Here they are, in situ:

gorton.tiff

The problem here is that while double-A-rated corporate bonds did indeed trade through triple-A-rate corporate bonds at the end of 2008 and beginning of 2009, Gorton’s explanation — even with two exclamation marks attached — is entirely wrong.

Finance Guy gives the long version of the takedown, and it’s well worth reading. But the short version is simple. Gorton thinks that triple-A-rated corporates gapped out because they were being sold off in “fire sales”. But in fact, triple-A-rated corporates in general didn’t gap out at all. General Electric gapped out, for very good reason: as David Merkel recalls, “GE Capital nearly bought the farm in early 2009″ due to the fact that it had a major maturity mismatch and was having difficulty rolling over the short-term liabilities with which it was funding its long-term assets.

In March 2009, GE’s CDS were trading at a spread of more than 1,000bp – and GE’s bonds made up the majority of the index of triple-A commercial bonds. (There are precious few triple-A commercial credits these days, and most of them issue very little in the way of bonds.) So it’s hardly surprising that the triple-A commercial-bond index gapped out — and the reason for it has nothing to do with forced selling, or even with selling at all. Indeed, my guess is that almost no GE bonds were sold during those periods.

If Gorton wants to provide evidence of forced sales of high-rated corporate debt at certain periods of time, he’s going to have to provide some volume figures, rather than trying to extrapolate volumes from price charts. Because the chart he provides simply doesn’t show what he says it shows.

(Incidentally, this is yet another example of the blogosphere being extremely good at fact-checking claims by experts. When done well, everybody wins: see for instance my friend Stefan Geens’s refutation of an article by the economist Craig J. Richardson entitled Visual Evidence of the Cost of Destroying Property Rights which was then picked up by Alex Tabarrok of Marginal Revolution. Once Alex saw Stefan’s post, he prominently updated his post to reflect the newly-revealed facts of the matter. I wonder whether Gorton will do anything similar.)

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