Cornell University Press Finance

We Have Badly Misunderstood These Institutions for More Than a Century

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Finance is fun, isn’t it? I have undertaken research on Wall Street, in London, and in other major financial centers around the world for more than thirty years. During that time, I have met a lot of talented and thoughtful people, which is what you would expect. What I did not expect to find was a lack of understanding of the major credit rating agencies at the heart of the securities markets—Moody’s Investors Service, Standard & Poor’s, and Fitch. Everybody knows of them of course, and some people will tell you the most egregious things about them, but after some time reading, listening, and asking questions, I realized just how misconceived the understanding of these organizations and what they do is amongst financial market participants, regulators, politicians, and the public. My new book is intended to alleviate this problem.

To my mind, the role of the author is to allow our curiosity to take us where it needs to go to come to an understanding of important things. That is what I have sought to do in my latest book, To the Brink of Destruction. I was never happy with the role attributed to the rating agencies for the instigation of the global financial crisis. At the time, the crisis was attributed to a melt down in the sub-prime mortgage market. But when I looked at the figures, the mismatch between a relatively small issue (sub-prime) and the onset of global crisis did not make much sense to me. The rating agencies were somehow in this mix, accused of messing up ratings and making bad securities look good. Once people realized the securities were no good, pandemonium ensued.

This account makes the global financial crisis look like an aberration, something caused by people not doing their jobs properly.

That’s a nice, neat story and the rating agencies were to me, useful fall guys. This account makes the global financial crisis look like an aberration, something caused by people not doing their jobs properly. I wish things were that simple. My book reveals a more complex picture and a profound lack of understanding of how things fitted together that is shocking to the outsider.

Three things really linger in my mind as the lessons of the crisis. First, the seemingly unstoppable onslaught of financial innovation, to which most of us, and certainly government, are spectators with limited understanding. Structured finance, which was at the heart of this crisis, is truly rocket science. Second, the rating agencies were rating legal contracts and were not rating creditworthiness in the traditional sense. Their role was transformed by this, but nobody seemed to realise this. Last, the key intervention of the United States Congress in the years before the crisis, in changing what counted as good collateral in the overnight borrowing markets for Wall Street institutions. Suddenly, exotic structured financial assets counted as good collateral, like US Treasury securities. Taken together, these three things combined to turn some little local difficulties on Wall Street into the worst economic and financial crisis since the 1930s.

The great expansion of public debt is likely to stimulate innovation, and that in turn will most probably make the agencies very active too.

Getting to the bottom of the issues I raise in this book is vital because the agencies are going to be crucial in the post-Covid world. Government debt increased in 2020/21 by twenty trillion dollars as of January 2021, due to Covid. Despite the talk about building back better, leveling up and so on, there is a strong undercurrent of belt-tightening and austerity as part of the process of returning to sustainable fiscal balance. This is just how government Treasury departments work. It is very likely then that rating agencies will play a bigger role scrutinizing public debt in future. The same warning is due for future financial innovation, which Covid did not stop. The great expansion of public debt is likely to stimulate innovation, and that in turn will most probably make the agencies very active too. My book offers a more accurate and realistic way of understanding what America’s rating agencies do, and why they do it. That is likely to be useful knowledge in the years ahead.

*Featured photo of Standard & Poor’s Headquarters from Wikimedia.

To the Brink of Destruction
Cover image of To the Brink of Destruction.
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Timothy J. Sinclair is Associate Professor of International Political Economy at the University of Warwick. He is author of The New Masters of Capital.

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