Lawrence J. White on the History of the Bond Rating Agencies

12 08 2011

Lawrence J. White, a professor at NYU’s Stern School of business recently spoke about the history of the bond rating agencies on the NPR radio show Planet Money.

He notes that there was a major change in the bond rating industry in the late 1960s. Up to that point, the rating agencies were paid by investors, who had a strong interest in getting accurate information. Under this system, the rating agencies did a pretty good job of separating good from bad investments.

In the late 1960s, the rating agencies switched to charging the people who were issuing bonds, which created all sorts of conflicts of interest. According to Professor White, this change was driven by technology.

White blames the shift on the invention of “the high-speed photocopy machine.” The ratings agencies were afraid, he says, that investors would just pass around rating information for free. So they had to start making their money from the company side.

Read more here.

Shoot the Messenger

12 08 2011

Standard & Poor’s downgrade of the U.S. government’s credit rating has created a furious political reaction in Washington along with demands that the firm be punished for its “unpatriotic” actions.

“Democrats and Republicans in Congress are gearing up to put it under investigative scrutiny and do more to restrict the influence of S&P and its peers in financial markets.”  Read more here. As I have mentioned in a previous blog post, S&P’s offices in Milan have also been subject to harassment by Italian police.

The ratings issued by these agencies may be unreliable, but I am very uncomfortable with restricting their freedom of speech.


Dan Gardner on Predictions

9 08 2011

I mentioned Dan Gardner’s book Future Babble, which exposes the prediction industry for being full of nonsense. I did so in a recent blog post on the S&P US debt rating downgrade.

Gardner was recently a participant in an online roundtable on expert predictions. Check out his piece, which was co-authored by Phillip Tetlock, and the response essays.

In my view, this is the key sentence of Gardner’s piece.

Despite massive investments of money, effort, and ingenuity, our ability to predict human affairs is impressive only in its mediocrity. With metronomic regularity, what is expected does not come to pass, while what isn’t, does.


Before you study the analyst’s report, study the analyst

8 08 2011

Yesterday I posted some questions about Nikola Swann, the S&P analyst who downgraded the US debt. I complained that we know almost nothing about Swann or the other individuals responsible for the downgrade. A helpful reader has provided some information that remedies the situation.

Nikola Swann is a Director, having joined the Toronto office in 2002. Nikola is primary analyst for the United States of America, Canada and Bermuda, as well as several public sector entities, including the International Bank for Reconstruction and Development, the International Finance Corporation, and la Caisse de dépôt et placement du Québec.

Prior to joining Standard & Poor’s, Nikola worked as an Economist in the Canadian Federal Government’s Department of Finance. Previously, he worked in the Monetary and Financial Analysis Department of the Bank of Canada.

So it appears that Swann was working in the Canadian government in the 1990s, when Finance Minister Paul Martin was battling to eliminate Canada’s the large fiscal deficit. Martin famously said that he would eliminate the deficit “come hell or high water” and would use any means necessary.  Martin managed to eliminate the deficit by a mixture of spending cuts and revenue increases. I’ve put the cover of Martin’s memoir below.

As the chart below shows, the Canadian deficit was mostly eliminated by spending cuts, but there were some tax increases that were part of the mix as well.

This background is critical to understanding why Swann’s report is critical of right-wing US politicians who think that deficit elimination can be achieved solely by cutting spending. The Tea Party movement is adamantly opposed to any tax increases whatsoever, even those that fall on just on the very wealthiest Americans (some of whom run the Tea Party movement).

It is possible to attribute Swann’s belief that deficit reduction take both tax increases and spending cuts to simple common sense. However, I also think that we need to take an individual’s personal and political background into account when evaluating their reasons for arriving at a particular position. In this case, we would look at Swann’s first-hand experience in a government that succeeded in balancing its books through a mixture of tax increases and spending cuts. Moreover, Swann’s perspective can be seen as reflecting the Canadian habit of seeking compromises or balanced approaches to problem, a habit of thought that informs Canadian thinking about the social contract. Most Canadians would shy away from a approach to deficit reduction that relied exclusively on either spending cuts or increased taxes on the rich. Canadians tend to gravitate towards the via media, the middle of the road. As I’ve argued before, the Canadian belief in compromise is something that we inherited from the United Kingdom. (See shameless self-promotion publication reference below).

My point is this: before you study the analyst’s report, study the analyst.

Many historians train their students using document analysis assignments. The students are given a particular document, say a papal bull or one of Napoleon’s decrees, and are then told to write an essay that discusses the document’s creator, the author’s context, and their motives for writing x, y, or z. It’s a great exercise as it imparts a habit of thought that the students can apply in their future careers, which will likely be in a field outside of history, such as business or politics or journalism.

It seems to me that in a future history class, students might be asked to do a document analysis of the S&P’s now famous report.


Andrew Smith, “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).

S&P Downgrade: the Canadian Connection, or, Who is Nikola Swann?

6 08 2011

As I mentioned yesterday, the S&P has downgraded the debt of the US. This decision was taken under the authority of one David T. Beers, who is Managing Director of Sovereigns & International Public Finance at Standard and Poor`s. Beers was quoted extensively in the media yesterday.

Yesterday I wrote:

Who is David Beers, the individual mentioned above? Is he a US citizen, a Briton, or someone else? If he is American, did he vote for or against Obama on 2008? We do know that he lives in Londonand once attended the LSE, but aside from that the public knows little about him.

Bond rating agencies have great deal of mystique around them because we don’t know much about the handful of individuals who actually make up the ratings.  Moreover, the bond rating agencies express their opinions in the form of quantitative scores, which seem very objective and scientific.

I’m not saying that David Beers is any more or less fallible than the next guy, but it is important to keep in mind that he is just one human being. Like all of us, he can be subjective. Can an American really be objective in rating the bonds of his own country?

I`ve done a bit more research. It turns out that Beers is North American, at least judging from his accent. Moreover, according to S&P`s press release, he wasn`t the primary analyst responsible for the downgrade. Apparently, the Primary Credit Analyst is one Nikola G Swann, CFA, FRM,  who is based in their Toronto office. Her contact details are (1) 416-507-2582;nikola_swann AT The secondary contacts were: John Chambers, CFA, New York (1) 212-438-7344;john_chambers AT, David T Beers, London (44) 20-7176-7101;david_beers AT I am posting their details here in case a journalist wants to get in touch with them.

We know even less about Nikola G Swann than we do about David T. Beers. This is a big problem. We know nearly everything about President Obama, Speaker Boehner, and the other major players in the political crisis of the last week. You can read Obama`s birth certificate online and can find out Boehner`s favourite brand of cigarettes. But we know next to nothing about the handful of individuals who rate bonds.

So who is Nikola Swann? Where did he go to university? Did he take any political science or economics classes? If so, what were the names of his professors? Is he a member of a political party? Does he have strong political views? Is he a Canadian or an American who lives in Toronto? If he is Canadian, is it possible that his views on the possibility of a US default are in some way connected to the anti-Americanism that is part of Canadian political culture and which has indeed been part of Canadian politics since, well, the end of the American Revolution? (Some Canadian nationalists would be gleeful at a US default, at least until their mortgage payments went up).  Is Swann an American who moved to Canada because he hated Bush? Or is he a fan of Fox News and Ayn Rand? We should have some answers to these questions before we put much stock in his opinions.

There are two things that really annoy me about bond rating agencies. First, their predictions about which investments are safe have been spectacularly wrong in the past. They have a terrible track record, yet people continue to respect their predictions about the future. Parenthetically, I would like to recommend a great book about the charlatans who operate in the prediction business—it’s Dan Gardner’s Future Babble. He says that people who make a living from issuing predictions about the future are right only about half the time, which is no better than flipping a coin. Moreover, their business model is “heads, I win; tails, you forget I ever made a prediction.”

I am very conscious of the mistakes that historians make. We are fallible and often misinterpret events in the past. But at least we are speaking about things have already taken place.

Second, because they are presented as quantitative scores, ratings of sovereigns are often regarded totally objective and almost scientific. They are not. They are likely influenced by the political views and ideological preconceptions of the individuals doing the ratings. Quantification gives a certain false authority to these opinions.  Moreover, these individuals that make up the ratings are subject to the same sorts of inducements are anybody else. I’m certain that S&P requires all of their analysts to put their assets into a sort of blind trust, to avoid the possibility of a conflict of interest. (Mr Swann may own US government bonds, but she wouldn’t know that if all of her assetts were in a blind trust). However, an analyst could easily be bribed by the nation-states they evaluate. I’m certainly not saying that this is the case here, but from the standpoint of a government faced with increased borrowing costs from a possible downgrading of the debt, it would certainly be worthwhile to bribe an individual credit analyst or even a company. Even though credit analysts are well paid, the bribe would not have to be large in the grand scheme of things.

Similarly, the credit analysts and their families could be subject to a campaign of harassment by state officials such as the police or the FBI. There is such a thing as shooting the messenger. Indeed, the Milan offices of two of the major credit rating agencies are currently being harassed prosecuted by the notoriously corrupt government of Silvio Berlusconi, which is upset over their downgrade of Italy’s public debts.

Moreover, even the best intentioned, disinterested, and best informed credit analyst is, at the end of the day, a biological creature like all human beings.

Earlier this year, Shai Danziger of Israel’s Ben-Gurion University published a study of the decisions made by the parole board in Israel. Danziger was able to get data on 1,000 cases of prisoners who applied to the eight-man board. Thanks to some very accurate minutes, he was able to determine the precise time of day the deliberations on each case took place. He found an interesting pattern. Immediately after breakfast, the judges on the parole board were quite lenient and granted around two-thirds of the applications before them. In the late morning, the success rate of the parole applications fell, eventually reaching zero. Immediate after lunch, however, the success rate rose, only to fall again over the course of the afternoon.

All of this raises the question: what did Mr Swann have for breakfast on the day she decided to downgrade the US credit rating? Given that the neither of the other major rating agencies, Moodyès and Fitch, have followed the lead of S&P in downgrading the US debt, this may be the right question to ask.

P.S. Update: it appears that Nikola Swann is, in fact, a man.  My apologies to all concerned.

United States loses prized AAA credit rating from S&P

6 08 2011
The US has lost its triple-A credit rating from S&P, one of the ten or so firms that rate the credit-worthiness of nation-states. See here.
“We take our responsibilities very seriously, and if at the end of our analysis the committee concludes that a rating isn’t where we believe it should be, it’s our duty to make that call,” David Beers, head of sovereign ratings at S&P, told Reuters.

The theme running throughout S&P’s analysis is the breakdown in the ability of the Democratic and Republican parties to govern effectively.

The agency said that policymaking and political institutions had weakened in the past few months “to a degree more than we envisioned.” This has major implications for the nation’s budget and debt problems.

I`ve blogged about the companies that rate bonds before. I`ve questioned the credibility of their ratings as predictive devices and have suggested that the only reason people pay any attention to these ratings is that there are US laws that force them to do so.
I intend to write a longer post about this in the near future. Right now, I would like to share a few quick thoughts or questions.

1)      Will other ratings agencies follow the lead of S&P?

2)      How will China react to his downgrade? What does this mean for Niall Ferguson’s concept of “Chimerica”?

3)      Will the US government try to punish or at least spy on the personnel of S&P? I can imagine some sort of informal punishment being meted out for this. The Berlusconi government in Italy has used the police for the harrass the employees of S&P and Moody`s in Milan. The apparent goal here was to intimidate the firms into keeping Italy`s rating high.

4)      Who is David Beers, the individual mentioned above? Is he a US citizen, a Briton, or someone else? If he is American, did he vote for or against Obama on 2008? We do know that he lives in London and once attended the LSE, but aside from that the public knows little about him.

Bond rating agencies have great deal of mystique around them because we don’t know much about the handful of individuals who actually make up the ratings.  Moreover, the bond rating agencies express their opinions in the form of quantitative scores, which seem very objective and scientific.

I’m not saying that David Beers is any more or less fallible than the next guy, but it is important to keep in mind that he is just one human being. Like all of us, he can be subjective. Can an American really be objective in rating the bonds of his own country? And if Beers is British, is he really qualified to speak about American politcs ?


Jack Goldstone of George Mason University recently posted an intriguing comparison of French public finances on the eve of the 1789 Revolution and American public finances today. What they have in common in the unwillingness of the top 1% of the population to make sacrifices. He points out some other interesting parallels as well.

When the world’s greatest power financed an overseas war with borrowed money, then  turned to its elites to approve tax increases that would fall mainly on the rich, they responded with a resounding “NO!”  The debt was not a reasonable result of government needs, the elites cried.  It was the result of waste and misguided government expenditures.  There was no way that the elites would consent to any increase in taxes without constitutional change; anything else would be a grievous assault on basic liberties.

That was in the summer of 1788.   The place was Paris, and after France’s successful intervention in the US Revolutionary War against Britain, it had debts to pay that required a boost in income. Although France was by a goodly margin the largest and richest country in Europe, and the most powerful military force in the world, its tax system was a twisted mess of special exemptions and loopholes.  Different regions of France paid different rates of taxes, and most elites were exempt from the basic tax of the country – the taille,
a land tax – on most of their income. The elites did have to pay an income tax of 5% — the vingtiéme – but that was due to expire, and the country could not pay its bills unless the tax was made permanent, and other taxes were made more consistent or increased.

To accomplish this, the French monarchy convened an Assembly of Notables, opened its books, and claimed that tax increases were essential to restore the finances of the nation, and prevent the country from being overwhelmed with debts.