Should We Care What Debt Rating Agencies Say About National Governments?

11 05 2010

The financial turmoil in Greece has focused attention on bond markets and credit rating agencies. The yields on Greek government bonds have shot up, meaning that it costs the Greek government to borrow money because investors think that a default is fairly likely.

The election of a minority parliament in Britain has created fears that that the agencies that rate the creditworthiness of sovereign debtors could downgrade UK bonds from the current AAA status. The Guardian’s Katie Allen reports: “The prospects of a weak coalition government has rattled UK markets, sparking growing fears that a downgrade to Britain’s coveted top-notch credit rating could follow.”

There have been repeated references to bond-rating agencies in the discussion of the various proposed coalitions in Britain. There was relief when one of the bond-rating agencies announced that the hung parliament would not affect the UK’s credit rating. “The fate of the UK’s gold-plated sovereign debt rating will not be decided until the end of 2010 despite a hung Parliament, Standard & Poor’s said.”  See also here.

Political commentators are quite right to pay attention to the reaction of the bond markets to political events. In the last few centuries, capital markets have proven to be a sensitive register of political and even military events.  For instance, during the American Civil War and the Second World War, the prices of the combatant governments’ bond fluctuated as news from the battlefield arrived. Financial markets can be spectacularly wrong when it comes to predicting the future (as the Sub-Prime Mortgage Crisis suggests), but overall they are useful tools. Capital markets exploit what James Surowiecki calls “the wisdom of crowds” because they aggregate the intelligence of large numbers of people. They also rely on the self-interest of investors: because people are putting money on the line, they are more likely to put aside sentiment (what they want to happen) and focus on what will happen.

The price of Confederate government bonds reflected events on the battlefield during the American Civil War. Image Courtesy Vanderbilt University Library.

However, I’m not certain that we should pay any attention at all to the bond-rating agencies, as they have had a spectacularly bad track record of predicting defaults by sovereign and other major borrowers. Just a few weeks ago, executives from a credit rating agency testified before Congress about their role in the sub-prime mortgage crisis. The rating agency is accused of having given unjustifiably high ratings to the mortgage-backed securities that were at the heart of the sub-prime mortgage crisis.  Gullible investors saw the ratings and then purchased the securities. When the dead-beat homeowners who were the other end of this complex financial chain defaulted on their mortgages, people came to realise that the securities were not nearly as safe as had been made out. Just today there was word that Moody’s, one of the bond-rating agencies, is being investigated by the SEC.

Much of the criticism of credit-rating agencies in recent months has revolved around the conflict of interest inherent in the agencies current business model, whereby borrowers rather than lenders pay the agency to issue ratings.  To my mind, this is only one of the problems with ascribing too much credibility to the statements that come out of bond rating agencies. Here are some other big problems with having credit rating agencies assign ratings to the debts of governments in large industrialized countries.

1)      Decisions are credit-rating agencies are made by relatively small teams of people, so you don’t have the benefit of the “wisdom of crowds” effect.

2)      There are currently few penalties for making a rating that turns out to be inaccurate. A bad rating agency is unlikely to lose business since the business of rating sovereign debt is very oligopolistic, meaning it is dominated by only a handful of firms. There is little competition, which means that a rating agency can deliver inaccurate ratings without fear of losing business to other firms. Moreover, the legal penalties for making an inaccurate prediction are unclear. It is true that the California state employees’ pension fund and other investors who lost money in the sub-prime mortgage meltdown are trying to sue the relevant credit rating agency, but it is unclear whether this lawsuit will be successful. The rating agency can always deflect charges that its rating was dishonestly high by pleading that they made the rating in good faith and that no human being is infallible.

3)      The agencies that rate sovereign debt are supposed to compete with each other, but it appears that they cooperate in rating countries.  Martin Weiss, the head of one such agency,  recently published an open letter calling on Standard and Poor’s, Moody’s, and Fitch to downgrade U.S. government debt. See here.

4)      Can political bias influence a rating agency’s statement? I wouldn’t want to question the professional credibility of Martin D. Weiss or anyone else as a rater of bonds, but it would be interesting to know if he is a registered Republican, a registered Democrat, or an Independent.  Being based in the academic world, I am very familiar with the phenomenon of professors who tailor their lectures and research to suit a political agenda. With historians, this is particularly likely when it comes to people dealing with recent periods of history and the histories of their own countries.  Academics can allow ideology to bias their judgement because there are few penalties for doing so.  The uncompetitive nature of the rating-agencies game and the fact there are few clear legal penalties may give a similar sense of licence to the handful of individuals who rate sovereign debtors. The fact that Weiss is an American means that his comments about the US government are likely to be coloured by his personal background. Perhaps ratings of sovereign creditworthiness should only be made by non-citizens of the country in question. Swiss experts should rate the US, and US experts should rate the Swiss government’s chances of defaulting. I must also say that Americans seem to get more emotional about their politics than the Swiss– this needs to be taken into account in thinking about how Americans speak about their own country’s chances of defaulting.

5)      Sovereign bond rating agencies haven’t been around for that long. According to Timothy J. Sinclair, the author of an excellent book on bond-rating agencies, rating agencies only really began rating government debt in the 1970s and 1980s. The fact that sovereign bond ratings were not around before the great defaults of the early 20th century makes it hard to tell whether ratings of sovereign debt are any good.

6)      The social, political, and monetary consequences of a default on government debt by a major industrialized country would be so massive as to destroy the legal and economic foundations of the bond-rating agency. To put things in human terms, I’m not certain what life would be like for a bond-rating agency employee in New York or London in the event of the collapse of the US government’s ability to pay interest on its debt.  Would the legal system still be in operation? Would paper money be worth much? Or would firearms and tinned food be more valuable in the new environment? How would the bond-rater be able to get off Manhattan Island?

This means that the ratings (i.e., predictions) issued by the agency aren’t worth that much. It’s like asking a bookmaker to tell you the odds of a nuclear war that destroys all live on earth. He is free to promise to pay you pretty much any sum of money he can think of in the event of such a war, because you won’t be around to collect it. Rating agencies may do an adequate job of predicting the chances of default on the part of a particular homeowner with a mortgage, company’s bonds, or even a small country like Greece.  I’m not certain rating agencies are equipped to predict the probability of truly catastrophic events of the sort that might wipe out the agency. Similarly, prediction markets can’t predict events that would wipe out the prediction market itself. This is the major problems I have with the prediction-market concept advanced by Robin Hanson. Prediction markets can’t deal with the once-in-a-lifetime Black Swan events.

I have one other point—Timothy Sinclair should complete the promising-looking website on ratings agencies he has started.

Laura Madakoro on Canadian Immigration Heritage

19 03 2010

Laura Madakoro, a PhD candidate in history at UBC, has published a great article on the social memory of immigration in the Globe and Mail.  Laura says that the Pier 21 Museum in Halifax is a great first step, but that the government needs to fund projects that will tell the story of trans-Pacific immigration into Canada. She also argues that online, as opposed to bricks-and-mortar museums, can help to educate Canadians about immigration history.

I have only a couple of things to add to Laura’s great article.

a) We shouldn’t forget the vast numbers of Americans who came north in search of a better life. These people crossed the border at many points, so it would be hard to select one spot for a physical museum. This is another reason why we should have an online museum.

b) We should emphasize the role of immigrant entrepreneurs — the Chairman of the Barrick gold mining company is a Holocaust survivor. Why not have a special museum for them in Toronto’s financial district?

c) Canada was a net exporter of people for several decades in the late 19th century. How do we tell the stories of the vast numbers of French Canadians and anglophones who went to the United States?

Two Solitudes and the Niqab

14 03 2010

That is the title of a piece by Margaret Wente in the Globe and Mail. Ms Wente makes a really interesting observations: “The Quebec-English [Canada] differences over immigration and integration echo those between France and Britain. France is contemplating a ban on the burka and niqab. In Britain, any politician who’d dare suggest such a thing would be denounced as a fascist. ”

[Shameless self-promotion warning]. Have a look at my recent paper on the British legacy in Canada. “Canadian Progress and the British Connection: Why Canadian Historians Seeking the Middle Ground Should Give 2½ Cheers for the British Empire” in Contesting Clio’s Craft: New Directions and Debates in Canadian History edited by Christopher Dummitt and Michael Dawson (Washington D.C.; Brookings Institution Press, 2009). In the paper, I argue that Canada’s colonization by the British as opposed to some other colonial power was a good thing overall. I don’t dispute that colonization involved massive losses for the First Nations and other groups, but we were lucky that Canada was part of the British Empire during its formative stages, rather than some other empire (the Spanish, French, or American for that matter).  One of the things that the British bequeathed to Canada has a firm belief in tolerance. Needless to say, tolerance is not an absolute: sometimes the virtue of tolerance needs to be moderated by other considerations. I don’t know that the right approach to niqabs in Quebec is, but I am convinced that the differences between Quebec between English-speaking Canada on this issue can only be understood by taking history into account.

There are many great essays in the Contesting Clio’s Craft book, so check it out.

My Teaching This Week

12 03 2010

HIST 1407

My lecture on Monday was a history of hockey in Canada. I spoke about the European and colonial antecedents of the game; the etymology of the words “hockey” and “puck”; the role of McGill University students in the creation of the sport; the history of the famous Victoria Rink in Montreal; the encouragement given to the sport by the Stanley family; the growth of inter-city leagues in the late 19th century; the amateur ethos and professionalization; the commercialization of the sport; the formation of the NHL in 1917; the first hockey games broadcast by radio; the impact of the Depression; how NHL managers worked to keep their best players from being conscripted in the Second World War; the first televised game; l’Affaire Richard; post-1967 expansion; games played against the Soviet Union; the introduction of professional hockey players into the Winter Olympics. I also spoke about changing gender roles, with a focus on the rise of women’s hockey and the decline of a sport for women called ringette.

Trudeau in Cuba, 1976

My lecture on Wednesday was on Canada between 1968 and 1984. In lecture, I talked about the epic struggle between Pierre Elliot Trudeau and René Lévesque over national unity. I integrated the Montreal Olympics, the November 1976 election of a PQ government; Bill 101, the 1980 referendum, patriation, “the night of the long knives”, and the 1982 Charter of Rights into the lecture. I also spoke about the National Energy Program, Canadian-American relations, feminism, and the emergence of environmentalism in Canada.

Alberta Premier Peter Lougheed and René Lévesque, 1981

In my lecture, I challenged several widely held myths about Trudeau: that his government’s policies were pro-environment (they actually encouraged people to drive gas guzzlers and Mulroney was a far better steward of the environment); that Trudeau was a solid Canadian nationalist (he allowed the American elephant to test its cruise missiles over Canadian soil!!); that Trudeau’s deficit-spending policies were very left-wing (every Western country did the same thing after the 1973 Oil Shock and the ratio of public debt to GDP continued to climb  in the Mulroney era); that Trudeau was a feminist (he only had one woman in his cabinet); that Trudeau was pro-gay (he decriminalized homosexuality, but this doesn’t mean that he thought gays were normal); that Trudeau gave lots of money away in foreign aid (foreign aid a percentage of GDP dropped from the high targets set under Pearson); that Trudeau was pro-immigration (the number of immigrants allowed into Canada was slashed in the early 1980s and was only increased under Mulroney).

Graduate Seminar

We discussed the following readings this week. Graham Taylor, “Charles F. Sise, Bell Canada, and the Americans: A Study of Managerial Autonomy, 1880-1905Canadian Historical Association Historical Papers (1982); Rob Macdougall,  “The People’s Telephone: The Politics of Telephony in the United States and Canada,” Enterprise and Society, 6 (December 2005), 581-587.

I thought that the timing of our discussion of foreign investment in the telecommunication sector could not have been more perfect, as the Conservative government has just announced plans to remove foreign ownership restrictions in satellites, telecommunications, and uranium mining.  As they say in pedagogy, this is a “teachable moment”.

Canada’s Accomplishments At the Olympics: Even Greater Than the Numbers Would Suggest at First Glance

28 02 2010

Canada’s Accomplishments At the Olympics Are Even Greater Than the Numbers Would Suggest at First Glance

Earlier this week, there was a lot of hand-wringing in the media about Canada’s alleged underperformance in the Olympics. I would imagine that the two gold medals in hockey will have dissipated this negativity, so perhaps posting these stats is now a moot point. However, one thing that bugged me about the complaints that Canada was third or fourth in the medal rankings is that so many of the complainers have overlooked an incredibly obvious fact, namely, that Canada’s population is rather small. In terms of medals per capita, Canada’s performance has been quite respectable. I was left wondering whether the give gold medals out to countries for having statistically illiterate populations.

Here are the medal ranking at 18:00 ET Sunday, 28 February.

Country Gold Silver Bronze Total
United States 9 15 13 37
Germany 10 13 7 30
Canada 14 7 5 26
Norway 9 8 6 23
Austria 4 6 6 16
Russia 3 5 7 15
South Korea 6 6 2 14
China 5 2 4 11
France 5 2 4 11

Here are the populations of these countries, courtesy of the CIA Factbook.

Country Population
United States 308,772,000
Germany 81,757,600
Canada 34,017,000
Norway 4,860,500
Austria 8,372,930
Russia 141,927,297
South Korea 49,773,145
China 1,336,090,000
France 65,447,374

It seems to me that the following are the stats we should really be paying attention to:

Country Medals Per Million Inhabitants
Norway 4.732023454
Austria 1.910920072
Canada 0.76432372
Germany 0.366938364
South Korea 0.281276178
France 0.16807397
United States 0.119829518
Russia 0.105687914
China 0.008232978

Or, if you prefer to focus on gold medals

Country Gold Medals Per Million Inhabitants
Norway 1.851661352
Austria 0.477730018
Canada 0.411558926
Germany 0.122312788
South Korea 0.120546933
France 0.076397259
United States 0.029147721
Russia 0.021137583
China 0.003742263

What does doing well in the Winter Olympics say about a country aside from suggesting that it has lots of snow? Canadians now need to have a debate about how what the most successful Winter Olympic countries have in common and what Canadians can do better in the future. My concern is that the excellent performance of a few dozen Canadian athletes at the Olympics will cause Canada to rest on its laurels. We really need to address the problem of our sedentary population.In 1973, Canadian TV stations carried a very controversial ad showing that the average 30-year old Canadian was about as fit as the average 60-year old Swede. The ad was soon pulled because it was deemed to be offensive to Canada. Since 1973, the problem of couch potatoism in Canada has only become worse. So what are the Norwegians doing right? What are the Americans, who have 300 million people, doing so wrong?

AbitibiBowater, Danny Williams, NAFTA, and the Future of Canadian Federalism

25 02 2010

The Grand Falls Pulp and Paper Mill as it Appeared in the 1950s

The inside of the mill

AbitibiBowater has filed a $500-million free trade complaint over the expropriation of some of its resource assets by the Newfoundland and Labrador government. In 2008, the company announced it was shutting down a pulp and paper mill in Grand Falls. Newfoundland’s Premier, Danny Williams then announced that it was going to nationalize the mill. Danny Williams was then dubbed Danny Chavez by the media, a somewhat inaccurate comparison with the leftwing and anti-American leader of Venezuela, Hugo Chavez.

Danny Williams

The company, which was incorporated in Delaware, announced that it was going to sue the provincial government under a provision of NAFTA that protects the property rights of American and Mexican firms in Canada. For the benefit of US readers, I should point out that Canada’s constitution does not protect property rights. In Canada, the theory is that all property is the gift of the Crown (i.e., the government) and can be taken back if needs be.

To make the politics of this case even more complex, the government of Quebec is now considering buying a stake in AbitibiBowater, which is now bankrupt and in court protection. The governments of Newfoundland and Quebec have never been able to get along. There is bad blood going back to a border dispute in Labrador.

I don’t think that Williams was right to expropriate AbitibiBowater’s assets without fair compensation. Seizing the asset in this way may discourage future foreign investment in the province. However, one thing about this story really disturbs me as a constitutional historian. The federal government, which had nothing to do with the provincial government’s seizure of the mill, yet it is Ottawa rather than the provincial government is being sued by the company.

The apparent thinking is that the federal government has a responsibility to foreign nations to control sub-national units. The problem with this is that management of Crown land and property and civil rights are clearly a matter of provincial jurisdiction. If the federal government can gain control over matters of provincial jurisdiction simply by signing a treaty with a foreign power, the authority of the province’s will be eroded. This is a case with momentous implications for Canadian federalism.

In the late 1930s, the JCPC, which was then Canada’s highest court of appeal was called upon to rule on the constitutionality of the Bennett New Deal, a package of federal legislation that dealt with matters previously considered to be provincial. Louis St-Laurent (see left), the future Prime Minister who was the federal government’s lawyer in this case argued that the federal government had acquired the right to legislate in this field by virtue of Canada being a member of the League of Nations, an organization that had set standards regarding working conditions. St-Laurent concocted an argument based on section 132 of the British North America Act, which gives the federal parliament authority to implement imperial treaties, in this case the labour aspects of the 1919 Treaty of Versailles.

In 1937, this argument was, essentially laughed out of court by the law lords of the Privy Council. Actually, what Lord Atkin said was that the mere assumption by Ottawa of an international obligation under a treaty did not alter the distribution of powers in the Constitution. Atkin said : “While the ship of state now sails on larger ventures and into foreign waters she still retains the watertight compartments which are an essential part of her original structure.” For the ruling see here.

One wonders how the Supreme Court of Canada would rule on a case in which the federal government claimed authority over a provincial matter by virtue of the NAFTA treaty.

As far as I can tell, no observer in the media has commented on the possible implications of this case for the constitutionality of federal policy under a future climate-change treaty. However, the connection between s. 132 of the constitution and the Kyoto Accord has been discussed by Chris Kukucha, a political science professor in Alberta.  Many in Alberta have argued that Canada’s decision to sign the Kyoto Protocol was unconstitutional because only the provinces have the power to limit greenhouse gas emissions and to sign agreements related to them.

Robert Gates, Afghanistan, and Your Laugh For the Day

24 02 2010

Robert Gates With Friend

Robert Gates, the US defence secretary, has criticized the unwillingness of most European countries to get involved in the Afghanistan war, claiming that the new-found aversion of Europeans to war threatens world peace. Gates’s claim is astonishing and laughable on many levels. I literally burst out laughing when I read his comments.

First, the cowboy attitude of the last US administration was itself a major threat to world peace. Second, anyone familiar with twentieth-century history should rejoice if Europeans are inclining towards a more pacific, post-nationalist frame of mind. Third, the death of European militarism has been greatly exaggerated: France continues to intervene militarily in its former colonies. The UK refused to participate in the Vietnam War, but then fought its own war over the Falklands, a conflict in which the US ambassador to the UN sided with Argentina. Moreover, most European countries have mandatory military service for young males, a policy that involves a tax in time that doesn’t necessarily show up in the stats on military spending as a percentage of GDP. Fourth, do we really think the world would be better off if Greece spent more on its military, or indeed any other branch of its bloated public sector? Fifth, can the US still afford the luxury of fighting these essentially recreational wars overseas? In the Bill Clinton era, the US was on track to discharge its national debt. The US budget deficit is now huge. Perhaps Angela Merkel should be put in charge of US public finances. Either that or the US has subscribe to the EU growth and stability pact.

What Gates’s statement amounts to is a plea for European taxpayers to bail out the US military. What the US needs to do is to let its military downsize and restructure in the same way General Motors is doing. When Gates opens his mouth, we hear the mating call of the spendthrift. One hopes that this is one mating call that echoes through the woods and goes unrequited.

Holdings of US Govt Debt By non-Americans are indicated in red, which is coincidentally the primary colour of the Chinese flag.

The basic problem with the imperial posturing of the US is that it wants to play at being an Empire, but it has a tax-averse population that objects to its current level of taxation, even though it is one of the lowest in the western world. Britain was able to defeat Napoleon because its wealthy classes were more patriotic than those of France and more willing to pay income tax. That willingness contributed to Britain’s ability to become a superpower while maintaining a low debt-to-GDP ratio. The United States of Glenn Beck, Sarah Palin, and Tea Parties can only be a superpower by using its credit card. That can’t last for long, and arguably that’s a good thing in the sense it would restore the US to the principles of laid out in Washington’s Farewell address, which was delivered at a time when the Americans were even more anti-tax than they are today. In any event, fighting little wars overseas is a distraction from the things the Americans are really good at, like integrating lots of immigrants and making nifty consumer products

A Symbol of the True Source of America's Greatness


I’m not saying that European countries are blameless. They do endanger world peace in a number of ways.  Preventing second- and third-generation Muslim immigrants from becoming citizens is a recipe for social disaster. Having established churches (as in England and, until 2000, Sweden) and crucifixes in government offices (as in Bavaria) is a formula for social exclusion. Voting for neo-Nazi and anti-immigrant parties is also a threat to world peace. Nominating the Danish politician associated with the Mohammed cartoon controversy to head NATO (!!!) is also a measure likely to exacerbate tensions between Christendom and the Muslim world. What the European need to do, however, is to imitate the multiculturalism of Canada and Australia, not America’s neo-Disraelian imperialism.

The US is obviously bullying its allies into sending more young men and/or money to Afghanistan. Canada has made it clear that its troops are coming home, its government having recently developed vertebrate tendencies in its relations to the Pentagon. Let’s hope that Canada’s government stays strong and tells the US to bugger off when it asks for more of our money!