Chris on the other hand has call on the assets whose cashflow is his debt is securitised against.

Also how liquid do you think the 30 year off the run treasuries are? Remember S&P downgraded US long term debt not t-bills.

S+P’s decision to downgrade the US is no more than a hunch that it is somehow riskier than it was in the past. But you don’t need the rating agencies to tell you that.

- If they aren’t roughly equivalent, then why do they usually match? S&P and Moody’s have similar looking ratings scales that, in my experience at least, most people treat as roughly equivalent. For example, the highest S&P rating (AAA) is considered more or less equivalent to the highest Moody’s rating (Aaa). This makes sense given that S&P and Moody’s most often give the same ratings to debt that they both rate. Split ratings (situations in which one agency provides a lower or higher rating than the other agency) do occur, but the vast majority of the time the ratings are the same. Given that split ratings are the exception, one might reasonably assume the ratings are roughly equivalent.

If Felix is going to explain the split rating on US debt obligations by asserting that Moody’s ratings include recovery rates and not just default rates, then how does he explain the fact that in most cases the ratings aren’t split?

- Recovery rates have more to do with general economic conditions than credit rating, per se. Both agencies publish annual default studies. For S&P it is the Annual Global Corporate Default Study and for Moody’s it is the Default and Recovery Rates of Corporate Bond Issuers. They used to be free but I think they’re charging for them these days. These studies present the average cumulative default rates by rating over the last 20 years or so. Moody’s also has a small discussion on recovery rates. Moody’s is very careful to state that recovery rates are much more highly correlated with general economic indicators than with the credit ratings themselves. Therefore, I perceive it is a common practice to assume a relatively similar (or even the same) recovery rate across all entities regardless of rating. So if you are Aa1, I assume a recovery rate of .45 and if you’re Baa1 I might assume a recovery rate of maybe .40. I assume a slightly higher recovery rate for the more highly rated entity, but not much. I should adjust those recovery rate assumptions in my model up and down based on general economic conditions. If that’s true, then the impact of embedding recovery rates in the Moody’s ratings isn’t likely to have a material impact on the ratings. Simple loss given default = Credit Exposure * default probability * (1- recovery rate). A 5% difference in your recovery rate just isn’t going to make a huge difference on a per dollar basis.

- Ratings are, in part, relative measures, not absolute measures. If Moody’s considers expected recovery rate in its credit ratings and recovery rate is highly correlated with general economic conditions, shouldn’t Moody’s ratings be more conservative than S&P’s given the weak state of the global economy? No, because the ratings are relative measures, not perfectly absolute measures. Moodys’ and S&P I’m sure have some standard guidelines about the characteristics of obligations at different ratings levels, but those guidelines shift over time. So it’s not a perfectly hard standard, to some extant it’s a relative representation of who’s the strongest and weakest in a given sector.

- Ratings are highly subjective. The ratings process is highly subjective. All kinds of guesswork and assumptions go into them that may or may not be true. Even though I personally think they do a good job on average, I have certainly seen them make some terrible assumptions in the energy sector, in particular with energy trading shops. My hunch is that the subjective nature of the rating process is likely to explain a much large portion of the variance in the credit ratings from S&P and Moody’s than the consideration of recovery rates.

Cee-Jay

It does cost money to service the interest on the debt – and all projections are that the debt increases. They differ how much. What if the projections are incorrect and the debt increases larger than projected? Relying on some of the politicians to make the numbers meet is speculative business.

What is the off chance that the debt increases from 15 T to 20 T, in say four years? Everything happens and you want to have (some) cushion of flexibility. See LTCM, it did not work out as well.

[...] [Meanwhile, the rating agencies have begun a guerrilla campaign of behind-the-scenes lobbying to weaken the commission’s efforts to carry out other parts of Dodd-Frank.

The S.& P. downgrade has elevated this simmering standoff to an overt clash. Politicians will be tempted to wave a white flag by granting the agencies a pass from tough regulation in exchange for the agencies’ not downgrading federal debt further. While that approach may give the United States breathing room in the short run, the government should not give in to such extortion.]

The subtext in S&P’s machinations is unsavory. Not only would many reporters rather not consider the subtext, they do not even want to bother reading the text. I have never seen so many blind byways in story coverage. Putting the microscope to the economic crisis as a text is productive. It might even work for CJR.

It is impossible to pay these taxes any more. The US Senate Banking Committee should take the lead in investigating S&P to help put an end to its miserable existence, and focus on how to initiate new international standards.

Opinions Washington Post
Global crisis calls for G-20 growth pact
By Gordon Brown, Tuesday, August 9, 4:55 PM

[...] [And if the problem is truly a global matter, are not many national conversations by definition incomplete and perhaps even self-defeating?

The world’s interdependence has once again been demonstrated in recent weeks. A loose statement anywhere can sink stock markets everywhere. [...]

Now, following a loss of confidence in the safest asset — sovereign debt — can the world come together to stop a new round of asset fire sales as liquidity in markets dries up? Either we cooperate globally, reforming the plumbing of our financial system, or the way banks and quasi-banks lend to each other will render monetary action ineffective, intensifying rather than resolving the crisis.]

But they can’t so it isn’t. S&P is part of the club. Therefore regulations are written such that their pointless ratings are valuable. I can see no justification for letting Moody’s do one thing and S&P something completely different. It seems to me clear that Moody’s approach is the one with some regulatory relevance. Is there any reason to allow S&P to rate as it does and treat its rating as useful for Basel ? I can see the point of avoiding a duopoly, but I can’t see any reason to give the same legal force to ratings which are not the same at all.

I really wish that I were confident that “And it’s conceivable that there was a tiny premium too for the fact that the recovery value on Treasury bonds is likely to be very close to 100%” is a joke. Yes indeed, if most money is handled by traders with horizons such that eventual recovery is irrelevant (not in their annual bonus and won’t keep them from being fired) then are huge difference in expectable recovery ratios would make a tiny difference in prices. It sure looks that way.

This means that a patient investor who cares about hold to maturity or recovery losses can make excess returns by buying lower rated debt. I believe that this is true of corporate bonds in the USA (by rating and vs Treasuries and using Moody’s rating).

I think that many investors overlook the detail that recovery ratios are not always exactly zero (so it is considered a financial joke when a bank in Korea wrote CDSs on its own debt).

Investors are more short sighted than you imagine possible even taking into account that they are more short sighted than you imagine possible (note I am open to the possibility that actual traders are perfectly rational given their contracts).

OR, it was a hollow threat, in which case why did they use it? The damage it has caused is real and has wiped trillions off World stock markets. Just for a bit of attention.

It’s clear Felix Salmon is getting desperate on his earlier lame defense of the indefensible S&P downgrade.

On the “econometric” side, Salmon now treats us to an explanation of how S&P does what it does in sovereign debt ratings which amounts to one of the best – though surely unintended – arguments for why S&P’s methodology is so one dimensional as to be, practically speaking, useless when it comes to rating sovereign debt. Why even bother when the methodology is so terribly flawed from an investor standpoint, especially since there can be undeserved consequences for a reckless performance, such as the one we have just seen.

On the political side, Salmon is either being disingenuous, or simply not a very perceptive reader of what Nate Silver wrote. A side-by-side comparison of what Silver wrote and what Salmon represents him as having written unfortunately strongly suggests the former.

Salmon writes:

“Silver also has a big problem with the fact that S&P ratings are more correlated with the Corruption Perceptions Index than they are with things like GDP growth or inflation, or debt. That fact, he says, “suggests that S&P is making a lot of judgment calls about countries.” Which, well, yes. Sovereign defaults are always political, rather than economic: if you looked only at macroeconomic ratios, then Ecuador should be investment grade, as would just about any other country which has recently defaulted and wiped out most of its debt. A sovereign credit rating is therefore primarily a function of a country’s willingness to pay, rather than its ability to pay.”

Silver wrote:

http://fivethirtyeight.blogs.nytimes.com  /2011/08/08/why-s-p-s-ratings-are-subst andard-and-porous/#more-14347

“What factors is S.&P. looking at when it rates sovereign debt? A country’s debt-to-G.D.P. ratio? Its inflation rate? The size of its annual deficits?

“S.&P. does look at each of these factors. But it also places very heavy emphasis on subjective views about a country’s political environment. In fact, these political factors are at least as important as economic variables in determining their ratings.

“For instance, the S.&P. ratings have an extremely strong relationship with a measure of political risk known as the Corruption Perceptions Index, which is published annually by Transparency International. These ratings have been the subject of much criticism because they are highly subjective, relying on a composite of surveys conducted among “experts” at international organizations who may have spent little time in most of the countries and who may instead base their judgments on cultural stereotypes.

“I don’t know whether or not S.&P. looks at these ratings. But the fact that the two sets of ratings are so closely related is troublesome. It suggests that S.&P. is making a lot of judgment calls about countries they have no particular knowledge about. Keep in mind that even when it comes to the United States, S.&P. made a $2 trillion error that reflects their lack of understanding of the way that bills are scored by the Congressional Budget Office. Are we to expect that they add value based on their perceptions of the political climate in Kazakhstan, or Cyprus, or Uganda?”

Is there anyone reading this blog who thinks that Salmon has not distorted what Silver said?

Notice in particular the deliberate – there is no other word for it — butchering of Silver’s sentence:

“It suggests that S.&P. is making a lot of judgment calls about countries they have no particular knowledge about.”

The whole point of that sentence was at the backend, where Nate says: “about countries they have no particular knowledge about.” Salmon leaves off the “they have no particular knowledge about” part and immediately segues into “Which, well, yes. Sovereign defaults are always political, rather than economic,” as if poor Nate had just said something so anodyne and obvious that any intelligent person would wonder why he said it in the first place.

Give it up Felix.

S&P shot itself in the foot on the econometric side, as Krugman et al pointed out,* and Salmon agreed, though he tried to trivialize this egregious error … and then take refuge in the validity – in his mind – of S&P’s political analysis.

And when Silver provided a powerful argument for why we should discount S&P’s ability in the area of political analysis as well, Salmon’s response was to grossly under- and outright misrepresent what Silver said on this point.

Very Republican of you, Felix.

Why not just admit “Hey, I sometimes make mistakes,” and move on?

*BTW, there was a similar pattern of misrepresentation in Salmon’s treatment of Krugman in one of his previous posts on this subject.

http://blogs.reuters.com/felix-salmon/20 11/08/06/the-credibility-and-integrity-o f-sp%E2%80%99s-ratings-action/

Salmon juxtaposed a quote from Krugman in which Krugman was excoriating S&P’s past econometric sloppiness – and current $2 trillion mistake — as disqualifying it from doing its downgrade with a quote from Tyler Cowen supposedly preemptively answering methodological criticisms such as Krugnam’s as being those of a “commentator … trying to muddy the broader issues.” Salmon – and, of course, Cowen – are free to disagree with Paul Krugman. But who except one of the autodidact trolls that frequent Krugman’s blog would ever accuse Krugman of “muddy”[ing], let alone not bringing into the discussion quite explicitly, the “broader issues”? In particular, I cannot imagine Tyler Cowen saying that Krugman was one of the commentators to whom his quote applied. Though that is exactly what Salmon disingenuously suggested by his juxtaposition.