Comments on: Rating structured bonds is impossible http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: Debt_Whisperer http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22730 Wed, 05 Jan 2011 23:03:00 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22730 The ratings agencies really should be limited to corporate ratings and traditional debt they issue. That is their core competency, such as it is and they are out of their depth in other arenas. Not just structured – look at ratings on banks, insurance and other FIs. It is almost a binary situation, because of the confidence necessary to operate those businesses. Lehman had an A+ S&P rating the day it filed. Bear was still investment grade (same as Enron) the day it filed. They can’t get their arms around trading and derivatives – you can’t imagine how behind the curve they are in these arenas.

Next shoe to drop? Public finance. Muni, sovereign and state ratings are a backwater in the agencies. The slowest of the slow and dimmest of the dim are sent to these pastures and the amount of analysis that goes into the munis is close to zero. Every state in the country is investment grade and all but one are in the A category or above – yet many states sit on the precipice of default. Ireland was in the double-A category as recently as last month. Just as with the intricacies of complicated CDOs and the like, the agencies don’t know how to handle debtlike obligations such as pensions – the very things that are dragging cities and whole states under.

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By: TFF http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22094 Mon, 20 Dec 2010 12:38:43 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22094 Very true, Danny_Black.

And when bond yields were falling, there was an incentive to construct higher-yielding “risk-free” securities. Didn’t work very well. :)

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By: Danny_Black http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22092 Mon, 20 Dec 2010 05:24:59 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22092 TFF, I can put it even simpler than that – “everyone wants a free lunch”. There is no such thing as risk-free. There are relative levels of risk and there are different types. For historical reasons, credit risk has got this privileged role – mainly because once upon a time people were buy and hold and there were less interest and FX fluctuations – but it is just one risk.

The demand for AAA is down to the continued misrepresentation of “no credit risk= no risk” and regulations that reinforce that view.

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By: TFF http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22089 Sun, 19 Dec 2010 17:21:04 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22089 dWj, can put it more simply than that…

We desire security in an uncertain world, so we invent a host of strategies (diversification, hedging, collateralization, structured bonds) that pretend to construct a risk-free portfolio out of securities that are anything but. None of these strategies are perfect, unfortunately, so we make ourselves feel better by tacitly agreeing to ignore their flaws.

If people were to stop paying a premium price for annuities and insurance products, and embrace the risk/return gamble, then there would be less demand for AAA rated securities and less motivation to manufacture them. But that flies in the face of our nature.

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By: dWj http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22080 Sat, 18 Dec 2010 23:16:58 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22080 So it’s a problem created by banking regulators and accounting regulators?

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By: TFF http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22078 Sat, 18 Dec 2010 21:51:26 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22078 If I understand it properly, AAA securities can be held at par value while lower-rated securities must be marked to market.

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By: dWj http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22076 Sat, 18 Dec 2010 20:11:19 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22076 Why are AAA ratings still so “precious”? Are there investors with old prospectuses that they hold a certain amount of their capital in AAA securities, or is this largely a problem created by regulators at this point?

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By: Danny_Black http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22031 Fri, 17 Dec 2010 17:45:04 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22031 Nick_Gogerty, and investing in dot.coms and emerging markets is what exactly?

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By: Danny_Black http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22030 Fri, 17 Dec 2010 17:44:09 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22030 I have a dream that one day certain myths will cease to be believed:

Credit-risk free=risk-free. All AAA is meant to mean is that there is a high probability that the obligation you have bought will pay out as per the contract assuming you hold to maturity. If you buy a US 30 year bond then AAA means if you hold it for 30 years you will collect all the coupons and get the principal back. It most certainly does not mean it is “safe” or “risk-free”. If you think it is then I suggest you have a look at the volatility on Treasury bonds over the last couple of months. The very simplest AAA instrument is one where you give me 100USD and I promise to pay you 0USD in return. There is zero probability of me defaulting on that contract and you are 100% guaranteed to receive that in 6 months time.

They are “too complex” to value. Hands up anyone who thinks it is harder to come up with a model that gives an accurate future price for Citigroup as opposed to one of their structured notes? Equities fundamentally are the most complex products to value objectively, the reason we know the price is because we can see it on an exchange and know if we hit yes we are more or less going to get that price. Liquidity difference not complexity.

Also there is no reason why credit risk should be static. No one expects other risks to be. Answer to all this nonsense is to stop privileging credit risk over other risks. Stop mandating that investors can palm off their responsibilities for analysing the risk – not just credit risk – and returns to the rating agencies and stop using discrete bands with a line below which all the sheep have to mechanically ditch the bonds.

PS Is this the same FT Alphaville that thinks deposits at banks are assets? Or that the ECB has a new rule allowing banks to post their **liabilities** as collateral for loans? I wonder if S&P will be linking to that article. At least Mr Salmon is honest enough to show any original errors along with the corrections!

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By: Nick_Gogerty http://blogs.reuters.com/felix-salmon/2010/12/16/rating-structured-bonds-is-impossible/comment-page-1/#comment-22018 Fri, 17 Dec 2010 14:09:54 +0000 http://blogs.reuters.com/felix-salmon/?p=6610#comment-22018 structured finance is the equivalent of 3 card monty without even the pretense of using a folding cardboard table for the show.

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