When in Rome...

I've posted recently about the S&P's downgrade of US Treasury bonds not having a lot to do with reality, and more to do with politics. Breaking Ground talked about how S&P made a $2 trillion error in their judgement, which meant they had no financial reason to make their decision, and instead fell back on a political judgment (because the US Congress took till the last minute - which any political scientist would likely say "so what" to). S&P had their reputation a bit bruised by that $2 trillion mistake, but they didn't stop there - S&P also downrated Fannie Mae and Freddie Mac to AA+ as well. It would seem as if S&P had an axe to grind with the way finances were working in America - and pundits all around argued about whether their opinions held water - but the fundamentals of why S&P did what it did was never discussed. I mentioned in Breaking Ground that there really were issues at play that demanded some investigation.

The Italians basically did that earlier this month when they raided the offices of both S&P and Moody's "in a probe over suspected "anomalous" fluctuations in Italian share prices." Basically the Italian government may or may not have had reasons to do this - I take it that anyone reading this wouldn't be surprised if a government decided to create a red herring in the form of a criminal investigation in order to draw away attention from financial issues - but suffice to say the Italians did it. The thing is that it hasn't stopped there.

The US Securities and Exchange Commission is investigating S&P now not only to see whether or not S&P had grounds to lower US T-Bonds to AA+  (and whether or not procedures were followed) but also investigating whether or not S&P participated in front-running their own release with insider trading actions. I should take this moment to clarify that the SEC isn't the most stalwart of investigatory bodies, PBS Frontline's "The Madoff Affair" spent the entire episode making a joke of the SEC as Madoff survived extremely vigorous investigations - and he wasn't just front-running, but rather was running a full-on Ponzi scheme.

The Italians and the US are both gunning for the ratings agencies apparently, but what does that mean? Your guess is as good as mine, but I'll give you my thoughts. There's the obvious outcomes: either there's truth to the claims and S&P is actually engaging in illegal behavior or the opposite could be true and these investigations are merely attempts to sully the reputation of S&P so their ratings are no longer taken seriously (and also to act as a warning to the other two ratings agencies). The former wouldn't surprise me in the least, but the conspiracy theory idea doesn't seem to hold much water for me - namely because US T-Bonds were selling at a profit to the US (across the TIPS/non-TIPS spread) after S&Ps downgrade as stock markets started shitting themselves leaving people only with the more secure options - US Treasuries or gold. Gold might seem favorable to some, The University of Texas system bought $1 billion in physical gold as a hedge, but gold is only worth something if you own the physical product and have it secured (preferably next to your canned food, guns, and ammo since you're apparently abandoning the world financial system). There are, of course, Special Drawing Rights which could be used to create a new global reserve currency - but this simply hasn't picked up steam.

Suffice to say that when times are tough and people are panicky they invest in something they're reasonably certain will keep their money safe. The really paranoid go for gold, and that's their right by all means, but the world isn't going to return to a gold standard or at least I hope not - the idea is insane not least of all for flooding effects if someone just suddenly tapped into a new gold vein and more generally the way Keynes described gold as, basically, "pouring money into a hole and then getting excited when you dig it back out" since gold has no intrinsic value. People are buying US T-bonds because despite all the paranoia, all the fear mongering, and everything else...people also like their TV, their hamburgers, and all those other "first world" accoutrement that come with the globalized world, and for that to stay in place the US economy can't just up and die one day. So investors pour their money into the US government and hope that somehow that pays off based on an incredible amount of even more money spent lobbying and strong-arming the US to do what capital wants it to do.

So what's that got to do with S&P? Chances are, if I were to gamble, S&P is probably doing things they shouldn't be doing. S&P might even have political motivations (based on the huge donations to the GOP) behind their debt ratings, which is bad enough to ruin their reputation forever, but if they're front-running as well then they're actually going to end up in prison most likely (or at least some patsies will). We're talking about a group of people that one other blogger described pretty harshly.

Look, I know these S&P guys. Not these particular guys — I don’t know John Chambers or David Beers personally. But I know the rating agencies intimately. Back when I was an in-house lawyer for an investment bank, I had extensive interactions with all three rating agencies. We needed to get a lot of deals rated, and I was almost always involved in that process in the deals I worked on. To say that S&P analysts aren’t the sharpest tools in the drawer is a massive understatement.

Naturally, before meeting with a rating agency, we would plan out our arguments — you want to make sure you’re making your strongest arguments, that everyone is on the same page about the deal’s positive attributes, etc. With S&P, it got to the point where we were constantly saying, “that’s a good point, but is S&P smart enough to understand that argument?” I kid you not, that was a hard-constraint in our game-plan. With Moody’s and Fitch, we at least were able to assume that the analysts on our deals would have a minimum level of financial competence.

I’ve seen S&P make far more basic mistakes than the one they made in miscalculating the US’s debt-to-GDP ratio. I’ve seen an S&P managing director who didn’t know the order of operations, and when we pointed it out to him, stopped taking our calls. Despite impressive-sounding titles, these guys personify “amateur hour.” (And my opinion of S&P isn’t just based on a few deals; it’s based on countless deals, meetings, and phone calls over 20 years. It’s also the opinion of practically everyone else who deals with the rating agencies on a semi-regular basis.)

All I can say is - ouch.  There's a lot of interesting stuff happening in political economy right now, and how it plays out will definitely affect the landscape of future attempts to reinvigorate interest in the ideas of the left. With the current debacles over the attempt to implement what is, in effect, a Republican healthcare plan requiring every American to enter into a private contract with a health insurance company (the Constitutionality of which is questioned) you have things like a recent report out of the UK which  showed the NHS to be one of the world's most efficient health care system in terms of costs - not surprisingly the US is one of the least efficient. If the US was serious about dealing with debt and demand suffocation within a capitalist narrative then the US should worry about a health care system that soaks up 15% of  its GDP. That's leaving alone all the talk of income inequalty and the never-ending wars / cost of empire, which I'm not going to get into again right now as I'm digressing too far as it is.

S&P's future is in doubt, that much is certain, and if this goes very badly then the fallout could be all the worse. It's going to be difficult to take debt ratings seriously at all if after the 2007-and-forward financial crisis, caused in large part by false evaluations, and then a ratings company tries to take on a nation-state only to be found to have made fraudulent claims that it fanned in an attempt to front-run the market to make a quick profit...that leaves some major questions about the financial system altogether. Questions that should have been asked a long time ago, but since everyone was "making money" hand-over-fist out of thin air no one wanted the party to stop.

Suffice to say I think if Marx was alive he'd have some great jokes to go with this.