S&P Ratings Destroy Information

By James Kwak

A lot of the theory of securities markets revolves around information: securities prices respond to changes in available information, you want to provide incentives for people to produce information, some kinds of information should be equally available to everyone, other kinds of information you should be able to trade on, etc. In the conventional model, rating agencies are information providers: they produce information that is useful to market participants, and thereby improve the functioning of the markets.

Well, forget all that. Nate Silver has the best article I’ve seen yet on S&P’s sovereign debt ratings, and the summary is that it isn’t pretty. Some of the things Silver finds, using some publicly available data and Stata, are:

  • Debt-to-GDP ratio alone is a better predictor of default risk than an S&P rating (meaning that the rating subtracts information provided by the debt-to-GDP ratio).
  • S&P ratings have almost no correlation with future default risk.
  • S&P rates European countries higher than other countries, all other things being equal—and look where that got us.
  • S&P ratings are serially correlated, which means they incorporate new information especially slowly.
Hopefully this will be one more nail in the coffin of regulations that incorporate NRSRO ratings.
(In other non-news, I’ve been forgetting to mention that I was on Benzinga Radio last week talking about the debt ceiling deal (mainly politics, not much economics). I was also on Letters and Politics on KPFA and KPFK in California this morning, talking about economic factors behind the stock market slide.)

31 thoughts on “S&P Ratings Destroy Information

  1. @ James Kwak,

    It’s more like you “destroy” or distort information. While true that blind dependency on S&P ratings is idiocy, nonetheless markets rely on information, true, false and in-between. You should have known that from the previous NRSRO debacle in mortgage backed securities.

    Again it is truly feckless of you to shrug off S&P as though it were a Consumer Reports rating, in your words. You’re likely to see some of your favorite social programs get cut just because of cascading downgrades.

    And just because you’re on the air doesn’t make you an expert, as it so tellingly shows.

  2. “The Mighty S & P Goliath has met its David” (S & P = Screw the People)

    Finally they will implode from their own ” Improvised Explosive Derivatives” IED’s – the poetic justice has me thrilled! From early 2000 to late 2000 this treasonous/ pyrotechnics organization has burned, and destroyed all but every thing they touched with their Midas Touch! (S&P / McGraw-Hill)

    Ref: “Subprime Mortgage Crisis” ____please note; S&P was responsible for most or all the Triple-A Gold-Standard Ratings,… pathetic!

    Thankyou James and Simon :-))

  3. The predictive record of past S&P ratings is interesting and relevant, but hardly persuasive in assessing the risk currently associated with US debt.

    To assert that US Treasuries are currently the safest securities available anywhere, one must believe that Congress’s recent failure to agree not to default until hours before it actually happened tells us nothing about the probability of default in the future. Do you really believe that that information is statistically irrelevant?

  4. For bullet #3, which two European and non-European countries have everything exactly the same EXCEPT for geographic location? Just curious which two countries fit that “all other things being equal” description.


  5. An obvious question is, What do S&P ratings correlate with, if anything.

    I think there other possible understandings of the information content of S&P (or Moody’s or Fitch) ratings. (How to formally treat this speculation, I have no idea.) First, they could serve as signaling method. At least part of the signaling S&P seems to have thought it was sending is that it is still a ‘player’.

    Second, I suggest that a given signal can have different information content for different recipients. It may have no content for one recipient and a great deal for another (the essence of coded information). Here, I am thinking of the great 1993 paper by George Akerlof and Paul Romer — “Looting: The Economic Underworld of Bankruptcy for Profit”. The government, Democrats and Republicans, have made very clear that Americans will be forced to insure the gross misconduct of the American banking system, the oligarchs, etc. Perhaps S&P and Moody’s and others can signal to prospective looters the likely targets for successful looting. No obvious application for this that I can see in the case of an S&P rating of US debt, and it is just as possible that S&P is a contemporary snake-oil salesman.

  6. In regards to sovereign ratings these are political organizations, not “fact source” organizations. The object is to influence the market, not report on it.

  7. @Hugh S.: I think much of what S&P did was to draw attention to themselves. If they had knowledge of the AIG lawsuit against BofA, they could pile on with their downgrade to see how big a ripple they could make in the proverbial market pond. As proof of the temporal nature of their acit, yesterday there was panic selling, and today 2/3 of the losses were erased. I have little doubt there was not some self-congratulation taking place at the highest levels of S&P.

    It will take time for domestic austerity to exert its deleterious effect on the economy. There are a number of voices on the Randian right arguing that cutting back sharply on social programs without a concomittant cut in defense will be fine, and so the market must wait and see how it plays out.

    On a related note, today’s guarantee of low Fed rates through 2013 suggest that there is a strong desire to keep the pedal to the metal and to avoid paying much interest. Imagine if T-bills had to guarantee 6-8% to get sold, never mind the interest rates we saw in the late 1970s. I liken our interest rate history to a nitrous kit that a kid buys and he thinks he can burn it the entire time he is out cruising, not realizing that it is a short-burst tool and not a chronic operating mode. As Ross Perot might point out: “Look, we’ve thrown a rod and we’re losing oil like a stuck pig, but if I don’t get under the hood of the American economy, then I can’t tinker with it and fix it up!”

    As a fiat currency, they can always simply print more $20’s to cover the waves of t-bills that will be cashed in over the next 20 years? It will be like Dan Akroyd impersonating Jimmy Carter on Saturday Night Live where he tries to convince the American voter that ‘inflation is your friend…now every man can smoke a $20 cigar!” (and then he lights one with a burning bill of currency).

  8. Well, Kids, so where’s the *DATA* you’ve all been living off of?

    Not sure when you know-it-alls are going to cry “uncle” and admit you need an accounting class…like RATigan raved – “we have a MATH problem”….

    Dan P? You still with us….?

    We really need to put the right numbers in the right column right about now….orcs are marching to make sure that ain’t done…so we better get at it…

  9. James – I listened to your KPFA interview, and you certainly nailed the entire economic picture! As you said, spending cutbacks will be harmful in the short term – why don’t people see that? It’s so logical…Also, I’ve taken an informal survey of everyone who will discuss this with me, and 100% of my polling sample agrees that small raises in taxes are preferable to cutbacks of services and more layoffs.

  10. S&P, Moody’s, Fitch, – these are the same pack of hobgobblins that gave AAA ratinging to PONZI scheme derivative intruments and operations in 2008, so obviously they have no credibility. Dito the Fed, the Treasury, and the socalled US government. We have crossed the rubicon. The entire horrorshow of USGOV, ECB, China Globalfinacialsystem are a corrupt and toxic cesspool of putrid, carnivorous, predatory malignancies that will devour all of us if we let it happen.

    Burn it all down! The sooner this monsterous malignancy – this cancer is burnt, excoriated from the face of the eath and thebodyhuman – the better.

    Don’t vote!
    Don’t give any money to any of these monsters!
    Quit pretending socalled politicians will work in our best interests. This is insanity. It is suicidal!

    Protest. Mass. Standup. Unite. In huge numbers Tunisian, London, Syrian, Egyptian, Lybian style resistances and DEMAND an end to this horror and wanton predatorclass criminal activity and supremist abuses and dominance NOW!

    The other option is submission and slavery, which is the predatorclass ultimate goal. The predatorclass will devour and enslave us if we let them.


    There is no legitimate political system!
    There is no legitimate legal system!
    There is no legitimate economic system!
    There is no ruleoflaw!
    There is no balm in Gilead!
    The world is controlled and manipulated by fascists and sociopaths in the predatorclass.
    They want our childrens blood, and will devour all of us if we let them.

    Our only hope is a realdeal horrorshow revolution and total destruction of the existing nefarious and foul structures and systems and socalled governments, – and then the birthing of new governments and systems and economies that promote and advance the best interests of the people. c

    Condemn and damn the predatorclass, – they are our mortal enemies.

    It’s us or them.

    Get stocked, locked, cocked, and ready to rock, – or go sheepishly to the ovens, or rendition torture chambers, or prisons, the HOMELANDSECURITYDENTION CENTERS, – or exist in abject poverty and debt slavery.

    This is the choice Americans must make.

    We are at war. This war is not one of our choosing. We did not start or propogate this conflict – this war is the work of the den of vipers and thieves in the predatorclass who are bent on destroying, enslaving, or eliminating the people and commandeering ALL of the nations, and the worlds wealth and resources! It is a war we did not choose, but one we can not ignore! Our enemies are bent on devouring us.

    How much abuse are we willing to take?
    How many crimes are we willing to ignore?
    How many lies must we swallow?
    How much deprivation are we willing to allow?

    Standup. Prepare! And get stocked, locked, cocked, and ready to rock Americans, because the predatorclass and their spaniels in the socalled government are pathologically bent on devouring us if we let them.

    In a world where there are no laws, – there are no laws for anyone predatorclass biiiiaaaatches!!!

  11. @TonyForesta: Good to start the day reading one of your signature posts!

    “Credit rating agencies are creatures of Wall Street. Just as they did Wall Street’s bidding in assigning investment grade ratings to derivative junk, they will do Wall Street’s bidding in downgrading the US credit rating. Wall Street might complain about downgradings, but that is just to disguise that Wall Street is calling the shots.”


    “Part of this goal is the new morality we need to build among the oppressed, which by now includes not just impoverished urban dwellers but all the non-rich, all of whom are on a direct downward vector to serfdom, no matter what their material status today. (As I wrote before, we’re all lumpenproles now.) This nothing but the same old Golden Rule morality among ourselves, Do unto others as you’d have them do unto you, but with the added emphasis on community and democracy, for by now we know it to be a law of history that if we don’t hang together we’ll all hang separately.”


  12. Is TonyForesta = earle of Florida? Are they related? Separated at birth? Or is Tony the new earle?

    @ Kwak, didn’t know you were holding a creative writing class in finance! Although, you do supply the fictional templates.

  13. If it is possible to borrow money at 0%, then why not start a business where you seek to buy every powerball ticket once the jackpot (say $50M) rises above the cost per ticket times the odds of winning ($1/ticket x 25M-to-1). And you can offshore the profits and patriate the losses, to minimize the tax burden. What a great business model. The only losers are those that buy all the losing tickets, but since most of them were going to lose in the next round anyways (where the jackpot would still be large if you had not won by buying up every ticket). Admittedly, splitting the jackpot with an office pool from Akron might be awkward, but nobody said getting rich was all champagne and caviar.

  14. The things is that for sovereign debt, there is no special information or expertise that the ratings agencies can bring forth that is not publicly available. With regards to any political analysis there are two questions. One is that this should be the province of political science experts and I doubt that S&P has that expertise to weigh in on the subject. Furthermore, the debt issue was out there years ago and while the economy has made it worse, political will to solve the debt outlook should have taken place from 2002 to 2006 -when the economy was trying to climb out of a financially led contraction- much more logically and so one should posit that S&P is being wildly inconsistent.

    In other words– S&P language is largely irrelevant. Additionally, since money will be invested in debt or equity the question is which and where and for how long. There is no such thing as risk free savings employment– cash, gold, bonds,and equities all have risks.

  15. S&P accused of behaving like SCOTUS:

    “The magnitude of their error combined with their willingness to simply change on the spot their lead rationale in the press release once the error was pointed out was breathtaking,” said Gene Sperling, the head of the administration’s National Economic Council. It smacked of an institution starting with a conclusion and shaping any arguments to fit it.”


  16. Jamesy my man,
    Here are a couple informative items from FTAlphaville you might find humorous if you didn’t catch them. And no offense to Nate Silver, but they know a little bit more about the topic than Mr. Silver—although the general gist would agree with Nate Silver’s findings.

    From a Neil Hume story in FTAlphaville:
    “And nowhere more so than France, where debt to GDP (let us not forget) is estimated to reach 85-95 per cent by 2013, depending on fiscal reforms, interest rates and growth, but not counting contingent liabilities from the EFSF.
    Indeed, that point has not been lost on other commentators. Pimco’s Mohamed El-Erian:
    ‘It is hard to imagine that, having downgraded the US, S&P will not follow suit on at least one of the other members of the dwindling club of sovereign AAAs. If this were to materialise and involve a country like France, for example, it could complicate the already fragile efforts by Europe to rescue countries in its periphery.’ “

    Also a little snippet from a Kate Mackenzie story, also in Alphaville, where she is actually quoting Citi’s Steve Englander:
    “S&P has repeatedly praised France’s fiscal program, but France also by far has the widest CDS of any AAA country.”

    The obvious question here is, when there are other countries (France etc) whose CDS are widening and much much worse than USA’s, why does S&P downgrade America before they downgrade France and other sovereigns??? This is the point that more commentators such as Nate Silver and the general public should be asking S&P.

  17. @ Title52
    (a suckling on a dried up teat,…for shame you increased your IQ by “2”? )

    Man, you are so predictable,… you’d be a great bait fish when I fish the Keys for a great white?
    Are you a Shakespearean lover #52(#50) – a fodder of the great plagiarizer, or a hopelessly lost, and forlorn griever to the loss of your messiah Buckley Jr., and grandiose days of pompous idiotic discourse? How many times must you cross the rubicon in your transitory quixotic lexiconism, caught between the horns of a self induced false dichotomy, awash, and bubbled-wrapped in a pastie alchemist primer-less chiaroscuro goo.
    Has your tongue yet unraveled this gordian knot, or are you stuck in between a rock-and-a-hard-place – better said Scylla and Charybdis? Please don’t weigh any risk of a thoughtless query,… that is the swallowing of quick`y cyanide pill – duly deserved or being “drawn and quartered”? Neither of, or for that matter, have any baring. Thus, the ultimated decision being your demise is fabulously inconsequential,… cheers :<0-

  18. @James Kwak “Hopefully this will be one more nail in the coffin of regulations that incorporate NRSRO ratings.”

    NOPE! You still do not get it Kwak!

    Hopefully this will be the nail in the coffin of those arrogant regulators who think they can play risk-managers for the world and arbitrarily set their discriminatory risk-weights that determine capital requirements for the banks based on the credit rating. Let the credit rating agencies do what they want to, but stop the Basel Committee and other regulators from imposing their stupidities on the financial markets

    Why should those perceived as risky originate basically all the capital requirements for banks while those perceived as not risky do not contribute? Is that not like telling those perceived as unhealthy to pay, besides the higher risk premiums they already pay, an additional premium so as to be able to further reduce the insurance cost of those perceived as healthy?

    By the way Kwak, S&P downgrades the US and suppose Moody and Fitch don’t. Who would you like your investor manager to follow when it comes to handling your own money?

  19. Per, you are over proofing again. Eventually it does back fire, just when we don’t know.

  20. @ earle of Florida,

    You’re even funnier when you’re mad, i.e. angry versus your normal mad delusional self. Not enough time to reach for the thesaurus or do a Google search, I see.

    PS, great whites tend like cold water more; your area is more the habitat of tiger or bull sharks and probably the occasional hammerhead.

  21. @ Title?

    Your actually more illiterate than I’ve given you credit for,… ?
    Demographics or geography have nothing to do with the obvious message you POS!

    Surely as a investigative malapropism creature – indeed, yours is that of a wholly inadequate linguistic sleuth,… mired in adolescence literature, whereas, crayola pictures drawn, filling-in the boxed pages is, an must be quite taxing! A puzzle to oneself,… but to be fair, what more can be expected from a 50-52 IQ,… my special admirer.

    PS. I’m done toying with you, and I shall resume my comments pertaining to James, and Simons’ blogs.

  22. @Tony – “….this war is the work of the den of vipers and thieves in the predatorclass who are bent on destroying, enslaving, or eliminating the people and commandeering ALL of the nations, and the worlds wealth and resources!….”

    No, this is the FRUITS of fractional reserve banking….c’mon, you MUST become a lying, thieving murderer to become *rich* in such a sick game – the game being that not enough *money* is ever in circulation to cover the interest owed on loaned *money* (money issued only as debt).

    That’s what is so INSANE about all of this – it’s a game RIGGED to make sure the scum rises to the top and STAYS there…

    So all we are seeing now paraded in front of us as *powerful* masters of the universe of an undiscovered circle of hell are those who lived their whole lives learning how to become the BEST lying thieving murderer…

    Maybe we need to all sign another pledge:

    “I am too smart to want to be the biggest lying thieving murderer on the planet. It’s a boring *career* choice.”

    Tony, if you need permission, I’m giving it to you. You have my permission to be just, fair, kind, generous, thoughtful, hard-working, honest – etc etc – the OTHER side of *human capital*….

    And please note that whenever you ARE in the, according to AynRand, spell of those delusional truths of a normal mind – any of those GENETICALLY HUMAN survival brain burps like FAIRNESS

    you will LOSE *money*….

    So unless we symbolically burn some toxic asset paper – I’d like to start with the Patriot Act – what’s the point of violence on the streets?

    *WEIRD* how Homeland Insecurity doesn’t think the *super* congress shenanigans is pouring gasoline over the 50 million unemployed – make no doubt about it that Kyl will casually toss in the lighted match…

    they shoot women in the head in AZ, just like in Pakistan…

  23. @ earle,

    POS?! My goodness, you’ve forgotten your thesaurus somewhere haven’t you? And no time to get Google all those literary allusions (illusions to you) to engender pretensions of high brow erudition.

    I’m sure you can a mail-order Harvard lit degree somewhere online. When you’re not “fishin'”, presumably.

  24. The purpose of S&P ratings is not to guide investors, but to set legal limits on what types of assets certain publicly subsidized institutions can invest in. That is why they came under fire – not because they were bad raters, but because they clearly subjugated their role to profits by selling good ratings to issuers (NBS debacle).

    Silver is right, but so what?

  25. Indeed, if we can nip-it-in-the-bud. But, is that all there is? The american people have an exceptionalism. A common thread of sorts, whereby this common denominator is in all our blood. The fulfillment of dreams,… independence, and the willingness to prosper if we so wish. This unique, virtuous, and embedded character is woven into the fabric of our souls. Yes, we’ve been hardwired since our founding fathers first inked the constitution, and will remain ever so faithful to that lasting doctrine – so help us “GOD”! (damn the atheist!)
    Our laws have been manipulated whereas the minority holds the majority at ransom. Please never,ever sell the american people short – fair warning to all – *[sic] for a active and assertive citizenry, is the best defense up against a usurpatory government*

    Thankyou Jmaes and Simon {Great Post as Usual,… getting huge traffic :-))}

  26. One thing I find very interesting is the language we use to describe the agencies. We say that “Moody’s”, “S&P”, “Fitch”, upgraded/downgraded.

    So we write “S&P downgraded US Debt”

    If you look at equities analysts or economists, you always hear “Joe Blow, analyst from UBS upgraded” or “Fred Bloggs, economist from Morgan Stanley sees weak growth”.

    So we write “Meredith Whitney downgraded Citigroup”.

    I guess S&P make about 50-150k for a sovereign rating, so if an analyst costs them say 300k a year with overheads, and they’re making a good margin (which I’m pretty sure they do), I would guess that the 80-100 odd sovereign ratings are supported by a team of about 20 analysts.

    Of whom I guess maybe 3-4 do North American sovereigns.

    I think this market conniption is based on what 3-4 guys reckon. It would be nice to know who they are.

  27. A basic perspective worth noting: Theoretically this is old hat “legitimation crisis” as espoused by Habermas as a major socio-political theory of the public arena. Specifically, it seems to be a well practices methodology under “chaos” and opportunity in the pragmatists and “realist” camps of “seize and capture” of financing the real politik of action and reactive status rank and power. In any case, here’s Dean Baker with a very substantial yet all too obvious (even boring?) truth to the political class dynamic:

    The S&P downgrade market plunge myth
    August 17, 2011

    Excerpt from Dean Baker:

    “Needless to say, those pushing for cuts in Social Security and Medicare will freely use the story of the downgrade market plunge to advance their agenda without fear of ridicule from the media. As a result, we can expect a continual parade of public figures saying that we need big cuts in these programs in order to prevent another market crash and economic collapse.

    If these programs are to be protected, it is essential that the public provide the missing ridicule. Any politician who has so little understanding of financial markets and the economy to blame the stock market plunge on the downgrade should not be involved in designing economic policy. Any reporter or columnist who makes such a connection should be in a different line of work.” [end Quote}

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