Thursday, August 11, 2011

The new S&P

Enjoyed this (emphasis mine):

S&P and other credit-rating agencies slapped AAA ratings on a slew of non-prime mortgage deals, long after their true value had become clear to many analysts--perhaps because they're paid by the banks whose deals they're rating, giving them an apparent incentive to offer favorable assessments. "It could be structured by cows and we would rate it," one S&P analyst wrote to another in 2007.

And S&P hasn't just missed the mark in sizing up the viability of toxic mortgage assets. As Nate Silver of the New York Times noted Monday, the agency's assessments of the likelihood of various countries defaulting on their debt in recent years also appear shaky. Silver, a respected statistical analyst, called S&P's ratings "substandard and porous."

And Nate Silver’s post which was referenced above (he may be skating a little closer to the edge than I would have liked, but nevertheless, point taken):
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.

S.&P.’s bond ratings from five years ago would have told you almost nothing about the risk of a default today. They had no insight about the threats in European markets, nor about which countries in Europe were relatively more likely to default. (Norway, which remains among the most solvent countries in the world, had a AAA rating in 2006, but so did Ireland and Spain.)

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