You Get What You Pay For

By Simon Johnson

Standard & Poor’s downgrade of United States government debt last month has been much debated, but not enough attention has been devoted to the fact, reported last week by Bloomberg News, that it continues to rate securities based on subprime mortgages as AAA.

In short, S.&P. is suggesting that these mortgages are more creditworthy than the United States government – a striking proposition. Leave aside for a moment that S.&P. made a big mistake in its analysis of the federal budget (as explained by James Kwak recently in this blog). Just focus on all the things that can go wrong with subprime mortgages – housing prices can fall, people can lose jobs, the economy may fall into recession and so on.

Now weigh those risks against the possibility that the United States government will default. As we learned this summer, that is not a zero-probability event – but it would take either an act of Congress, in the sense of passing legislation, or a determination by members of Congress that they could not act. S.&P. finds this more likely to happen than some subprime mortgages going bad.

Now S.&P. might be right, of course. Or its assessment might be influenced by the fact that it is paid by the issuer of those mortgage-backed securities – which presumably wants a higher rating. The rating agency’s employees may want to do an accurate assessment; management can reasonably expect to make higher profits if its ratings please the paying customers.

Perhaps we should just disregard what S.&P. and its competitors say. But this is not so easy, because many investors are guided by rules – either self-imposed or created by regulators – that tie investment decisions, and thus these investors’ holdings, to ratings. Ratings changes undeniably can move markets.

How can we take seriously a rating agency that is compensated by the issuers of securities? This system has long outlived its usefulness and should be discontinued.

In a similar vein, let me ask why we should take seriously economic analysis offered up by a financial-sector lobbying group on behalf of its members — if, for example, it says that regulation of its members will slow economic growth? Surely, we should check the numbers in the analysis carefully and be skeptical of the policy recommendations.

A timely example comes from the Institute of International Finance, which calls itself “the Global Association of Financial Institutions” and whose board members are all from big banks. (Indeed, the institute is more than a mere lobbying group; in the recent Greek debt negotiations, it was in charge of coordinating the terms proposed by private-sector banks for their involvement in the debt restructuring.)

So what do we make of its policy recommendations? In a report released this week, “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework,” for example, the institute asserts that additional capital requirements for its members could result in “3.2 percent lower output by 2015 in these economies than would otherwise be the case” (see paragraph 5 of its news release).

In recent conversations with policy makers from the Group of Seven nations, I was told that the institute’s previous, interim report on this same topic was largely without value (some said completely without value).

I hope the official policy community reacts the same way in this instance, because the institute refuses to acknowledge the vast cost imposed on society by the combination of big banks, high leverage and low capital that it endorsed through 2008 and that it defends, without only minor modifications, today. (James Kwak and I wrote directly about these issues in 13 Bankers – and we’re now hard at work on the sequel.)

The institute’s report is nothing more than lobbying masquerading as economic analysis. And just as S.&P. is paid for its ratings by the issuers, the institute is paid to represent the views of big banks. We would be wise to suspect that in both cases, the paying customer would prefer a particular outcome – irrespective of what the evidence says.

An edited version of this post appeared this morning on the’s Economix blog.  It is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

33 thoughts on “You Get What You Pay For

  1. @ Simon, you’re such a polite person. Everything you say is so true. I prefer bare-knuckles, though.

    fact is fact: these “rating” agencies are bought and paid for, and acted in ways that are very likely criminal, via knowledge of fraud, (whether actual knowledge or being in a position to make a reasonable connection that fraud was the underlying dynamic), collusion, and from these acts, enablement of grand, pervasive theft via its’ clients misdeeds.

    It would make my DAY to see indictments being sought by the appropriate US Attorney office, because this is the ONLY way to stop these assaults on civilization. And let’s be clear, that’s exactly what’s going on.

  2. @Woop
    “Assaults on civilization”? Isn’t this just ordinary tooth-and-claw capitalism? Bankers and aggregations of bankers defend their own interests, not yours or mine. Simon ‘s point is that ratings agencies, by contrast, are there to serve an ostensibly “public” purpose, not to be shills. If they do not serve that public purpose with integrity, they should not exist. The ratings agencies are re-creating the situation of doctors who serve pharmaceutical sponsors rather than the interests of patients. We should not tolerate it, but it’s doubtful that fraud statutes take this explicitly into account.

  3. A key problem is that companies choose which firms rate them and then pay for those ratings. It puts pressure on the agencies to award better ratings.. It is silly that despite all their obvious mistakes they continue to rate corporate and public debt, and have preserved their position of influence in the economy.

  4. Didn’t we also learn that there is a zero percent chance that the government will let huge mortgage debt holders fail? I’d feel incredibly safe investing in subprime crap through Citi or Goldman. Even if the loans go belly up, the bank and investors will be made whole from Uncle Sam.

    Long or mid-term US debt is another story. Much more risky. True, you’ll likely be paid back in dollars, but those dollars will have a fraction of the original invested value.

  5. Woop, its been going on since most of todays people were kids. I don’t recall one public grade school teacher ever picking up a tooth brush and describing its use. Sure, at home we were shown a toothbrush and tooth paste, but had no idea how to properly use them. All the while there are holidays year round that promote tooth and mouth decay with reckless abandon and advertizer money. Then sends you to a person who has every motivation to keep you comming back for more, until you spent your last dollar or your mind gives way to the realization that the education you recieved and the reality you are living, are two totally different realms and there aint a thing you can do about it. Finance is the same way, it just recycles money through the same type o birds.

  6. Bond ratings are not a public good; they are a private good as they benefit (in theory) institutional investors. Just because they are publicly disclosed does not make them a public good.

  7. I’m increasingly convinced that capital wants hard money at this point, for zero-sum gains consolidation rather than any lack of understanding of macro, and is lobbying major economies in that direction. The easily solvable but not solved Euro crisis, and the US debt ceiling farce, are deflationary policies rather than mistakes. I see the S&P downgrade in the same vein: a political move against soft money (against QE or inflation as policy tools).

  8. If U.S. government debt goes bad, any subprime mortgage debt will almost necessarily go bad. A downgrade in government debt should automatically trigger a downgrade in all other debt held in that country. Our economy is dependent on U.S. government debt. S&P isn’t credible and, as we know from the housing crisis, hasn’t been credible for years.

  9. @Anon – that’s not true. Government debt is only backed up by faith in the government. Mortgages are backup up by real assets. If government debt goes bad, everyone will likely take a hit, but holders of unpaid mortgages hold claims on the asset – the house; holders of bad government debt hold claims on faith.

  10. @Dave

    So the banks hold 83% of Las Vegas *underwater* mortgages – congratulations on acquiring the assets by leveraging 60 to 1…

    Fun with numbers – everyone can play?

  11. I guess we all get what we pay for when it’s cut in stone? This sad and sorted tale reminds me ironically of,…”Pygmalion and Galatea” the Greek mythology legend of mortal narcissism [?] – where the TBTF’s are Pygmalion, and the Standard & Poor’s (CRA’s) are Galatea. The twist is the limestone used, is of a hardened pyrites alabaster clay from the Federal Reserves Jekyll Island vocanic fault-line depository,… now located in the “Global Association of Financial Institution’s” summer retreat, “Potemkin villages”,… along the Hudson and Potomac River, whereas said dwarfed scantily by larger-than-life, “Rip Van Winkle’s napping, and surviving on their “Philosopher Stone”, and quarrys’ lapidary entrails?

    PS. No other way to show my disgust in a sarcastic rant, wrapped in half-truths?

    Thankyou Simon and James

    God Bless You, Julian Assange

  12. @Simon,

    And you’re surprised at this perversity? This is in the context of incentives as a driving force of economics, which presumably you’re familiar with. I.e. poorly designed incentive systems create poor results.

    Be careful what you wish for when you beg for more capital in the banks. You may indeed get it, but the results may once again be perverse.

    Wide eyed wonderment is for children and academics.

  13. I like your blog, but I find this post very annoying. Your first paragraph implies that it is hard to fathom how a AAA tranche of a subprime pool could possibly be rated higher than the US treasury. I can’t help but wonder if you understand how securitizations work, because this reminds me so much of the “you can’t turn garbage into gold” statements that were so popular during the recession. The whole point of securitization is that you can tranche the risk buckets in an almost infinite number of ways. Unless you are seeing default and severity assumptions on subprime tranches that you find problematic, then this post is pointless. And while I’m not against reforming the rating agency space, I’ve had a hard time coming up with a good way to do so; at least if we want the ratings to be available to the public.

  14. @Dave the gap in your logic is that only the government deficit, or rate of increase of debt, is inflationary. Government can pay for its deficit by printing money (very inflationary) or by issuing bonds (much less inflationary) or by some combination. In practice, a few percent growth requires a few percent monetary expansion to match and keep prices constant, and there should be no difficulty achieving that through bonds and the banks without inflation problems. The main thing though is that the total amount of debt is not a cause of inflation. There’s nothing that says at Debt/GDP = X you get inflation.

    There’s an unlikely scenario where treasury bond holders demand to get repaid (in dollars) rather than roll over into new treasuries. If, say, the holders of 30% of US debt conspire to call the debt the US government will have two options: 1. Print some trillons of dollars to give them, causing a big inflation shock and eroding dollar values for everyone (so creditors aren’t going to ask for this out of bona-fide self interest). 2. Saying “no” and rescheduling in some way. The US cannot get into the position of Greece. Greece is effectively a private firm, and it doesn’t have option 1.

    Ironically for the hard money proponents, contraction of the economy will cause inflation. If the available goods and services go down while the money supply stays constant, that brings a very real risk of uncontrolled inflation.

  15. @ Jake, hello. I would argue this is extra-ordinary “tooth and claw” capitalism, in terms of the broad of negative consequences, whether intended or un-intended. If you lost part of all of your pension benefit due to criminal conduct, you might begin to see the “assault on civilization” is something greater than a melodramatic flourish, or term of art. If your national treasures become subject to privatization, you may see this a a painful negation of thousands of years of human perfection through art and architecture.

    At least, this is my perspective.

    I think I am reasonably certain I Understand the meaning of our Simon’s post, since your expression of it is really also in conformity with my own.

    Where I differ is in the application of the US Criminal Code: in fact, extant statutes address all of the schemes and artifices depriving people and organizations of their honest labor, and I can cite these if you should ask.

    Absent that, I do have a parting comment on the profession of psychiatry as practiced today in most clinical settings: largely, these doctors are paid-drug pushers for BIG PHARMA, often prescribing medications leading to adult onset diabetes, neurological impairments, and other effects which dull the senses of being a human being. It is total quackery, charlatanism, and a complete divergence from competent medical care, in my view.

  16. @woop

    Detroit, Michigan.

    Ivory Tower analysis of theoretical economic models meets babushka busybody social engineering meets actual engineers, anyone…?

    Didn’t think so…how about at least a psycho-analysis of one of Detroit’s infamous sons – the War Lord, “Prince of Blackwater”?

    I’d like to hear some citations from the US Criminal Code if only as a historic reminder that something resembling *law* was imagined before the *Information Age*….

    Obambi speaking in the background…no one can argue the natural *preacher* talents of the man…marketing at it’s best….

  17. It certainly appears that universal directives are being forecast to correct a rudderless ship without a fixed port. A report in the ECONOMIST would seem to indicate that the wind blows differently for distinctive sectors. Apparently what is good for the goose is not so good for the gander and the commercial distinctions are separate from the financial interests (if not at odds):
    Global business barometer
    Business blues

    Aug 11th 2011, 16:00 by The Economist online

    Global business sentiment has turned bearish

    “EXECUTIVES who expect global business conditions to worsen now outnumber those who think things will improve. The Economist/FT survey of over 1,500 senior executives, conducted by the Economist Intelligence Unit, had a positive balance of 19.3 percentage points in May. It is now at -10.5 percentage points. Only 23.3% of respondents think that business will improve in the next six months; 33.8% say conditions will worsen. Economic and market risk is by far the biggest worry for business. With regards to banks, 59% of respondents think big banks are escaping appropriate regulation (though only 46% of those in financial services agree). Most would like to see greater capital reserve requirements.”
    (full article:

    Meanwhile: back at the ranch: Maybe you don’t actually get what you paid for?
    America’s dodgy financial plumbing
    Too big a fail count
    The sheer number of unsettled trades is rattling regulators
    Jun 2nd 2011 | NEW YORK | from the print edition
    “CLEARING and settlement are supposed to ensure that share, bond and derivative deals are completed safely and on time. These back-office processes are arcane, unglamorous and too often taken for granted—until things go wrong, when their importance becomes painfully apparent. The financial crisis of 2007-09 and the “flash crash” of American stockmarkets in May 2010 revealed numerous faults in the plumbing. Efforts are under way to mend these, but regulators have been slow to attend to some worrying new blockages arising from today’s high-frequency and tightly coupled markets.”
    (full article:

    And then: without going into the question of whether off-shore finance rules the world of a black ops-market; here’s a fascinating look at what could be the movie of the week model on economic rule itself:

  18. @Woych

    Nihilism on all fronts, eh?

    SEC is destroying documents once their investigations are completed and *analyzed* move on folks, no data here

    …it’s Main Street News now…

    Yup, start pouring money out of the skies over Iraq (don’t shoot, we will pay you not to shoot) and soon everyone gets an even better idea about *getting some*….

    but why is everything from 2006….? This goes back a LONG time in Russia – Gorbachev, at least…

    first Russian rocket that went up with supplies for the space station blew up with the payload – O-ring saga or paybacks?

  19. Can’t resist, one right-to-work slave labor wages AZ electric company worker manages to not follow the paint by numbers and shuts off the power grid in southern California…!? Really?!

    ONE worker? According to OSHA (shut the door on the critics keying up their *gubermint* noise), there has to be a minimum of 2 people on certain jobs – which even if there were 2, what is typical in AZ is that the rabid republican alcoholic is the *boss* and the worker has to follow the stupid *cost saving* directions of the alcoholic…

    Funny how the grid knocked out is one that was SECRETLY modified by Enronistas…all in the history books now, these contributions of Gen X to infrastructure and architecture – up to and including the unpaid for potholes their gas guzzling SUVs created….productivity and meritocracy, NIHILISM-style…

  20. To wanna be musician, mathematician and rethug wrecking crew boot licker Joe Scarborough – you might have missed this:

    DO tell how *we* are all supposed to be remembering – how about Joe review his *comments* in the past 10 years….

  21. What about the upcoming IMF GFSR-report the other week where some of the authors told the IMF was using the methods hedgefunds valueate CDS to find out how strong slash how weak European banks are: is this The Big Short 2.0, or what?

    O yeah, both ratingagencies and IMF, both hedgefunds and (followers of) Ayn Rand, both Greenspan and the son of Friedman are busy ruining the EU: anarchy capitalism indeed, made in the USA so the sinking of the world economy al a Rand, without large scale strikes from tycoonbs, no, via strikes from within the core of financial engeneering, via the Fed with its Primary Dealer Credit Facility where $2 trillion went to Merrill Lynch alone, rolling over loans whateever, they needed and got $2 trillion to roll those over….

    O yes, Helicopter Ben is Helicopter Ben allright, be it that he drops it all in one lap, that of the usual suspects.

    I kind of hate the US of A, exept for most of its people, I mean. for what “the US” is doing is what Govenor Perry said, this time in my own words: it is financial terrorism (and therefor treason). beggar thy neighbor, whereby the 2-year interestrate for Greece has soared to 60% (10-year rate to 20%)

    So, pretty soon, perhaps, we can write the obituary of our beloved Euro, thanks to “you ASS of A”

    That being said, you troubles are far from over, so Stiglitz is right, sooner then he thought perhaps: the sinking of the world economy is near. this time is not so different, isn’t it.


  22. Ya get what ya pay for, pure and simple, as Simon points out. How to reform the ratings business? I have two suggestions. First, prohibit reliance on “issuer pays” ratings for regulatory purposes and go back to the “user-pays” model that was in place until recent years. This approach reduces potential conflicts to a minimum. If not satisfied with this approach, abolish all regulatory references to such ratings, require regulated purchasers of debt to perform their own due diligence without reliance on ratings. In this computer age, ratings are outdated. Analytical programs will be commercialized, their assumptions and methods subject to market criticism, so that purchasers of debt and debt-like securities can use to various models to measure and price risk. Moreover, why should investors pay outlandish administrative costs to money managers who rely on ratings and sales talk to make investment decisions on their behalf?

    Similarly, industry sponsored “research” should be identified as such whenever cited and, if such research has been criticized by peer reviews, the criticism should be cited simultaneously whenever government statements refer to industry sponsored studies. This approach serves several useful purposes: it arms the recipient with useful information and ensures that the government official or agency that cites such research identifies sources that qualify or criticize that on which the government relies. While we cannot force them to read it, we can at least establish that they are aware of it and that their failure to read it constitutes negligence or reckless behavior.

  23. @Woop

    And they are really *lazy* now – paint by numbers schticks to crawl into OUR heads…

    Look at the latest *red alert* – NOTHING has changed! As if they did NOT get their hands on the *intel* Osalami had after they *eliminated* him….their *logotherapy* psychobabblists couldn’t use that *fact* to climb into THEIR heads??!!

  24. @ Annie, it’s a long-running “psy op”, orchestrated by real psychos, and underwritten by satan.

    Of course, I am preaching to the choir…..:)

    Good will triumph, be stout of heart, therefore. Your MIND is better, stronger, more evolved, and more in touch with the universal principal of light, than these TWIRPS will ever be. We will not be defeated, ever.

  25. @woop – “….it’s a long-running “psy op”, orchestrated by real psychos, and underwritten by satan….”

    You are giving them too much respect – they are MONKEY BRAINS with imagination….if all they can conjure up and apply themselves to is sadism, then WHY give them any tools – as a CIVILIZATION – other than rocks and stones and bare hands…?!

  26. @ Annie, and a SLEDGE HAMMER, to be breaking big rocks into smaller ones, on the ROCK PILE, where such deviants should be spending their days! No kidding.

  27. @Woop

    From the most censored book of all time (First Amendment anyone? Freedom of Speech = Freedom of Religion – like duh) comes this ditty, “…But the survival character of a soul is not fostered by attempting to secure peace of mind at any price, by the surrender of noble aspirations, and by the compromise of spiritual ideals; rather is such peace attained by the stalwart assertion of the triumph of that which is true, and this victory is achieved in the overcoming of evil with the potent force of good….”

    Who CARES that Randbites don’t believe in an immortal soul?

    I wouldn’t give them a sledge hammer :-) Let’s see if they have the MIND capacity to invent one based on rock sizes and strengths…

    There are an amazing amount of life forms on the planet that liars thieves and murders don’t know about – willful ignorance.

    But how SANE is a HUMAN mind that would listen to a maggot’s ECONOMIC analysis of a dolphin’s LIFE to be a sign of *intelligent* government capabilities?

    I saw graffiti on an overpass yesterday that said “DRAFT ANNIE”


    The reason that the neocon wrecking crew rethugs and their sociopath sycophants work 24/7 to makes sure an HONEST LABOR *middle class* person will NEVER get into politics is because

    OUR tax records being made public would be PROOF of the ongoing WAR of THEFT being waged by global criminal cabals.

    We The People are NOT being *allowed* to make our lives less miserable through HONEST WORK.

    It’s a WAR they declared it and are waging it 24/7!!! Look at the apparatus of spying that they have erected – *homeland security*!!! There IS a definite conncetion between the rise of that apparatus and the dissolution of *economic* security for 58% of USA citizens – technology my a—

    And we better stay focused on the key battles that we need to win….Economic disobedience in this web of fraud and treachery MUST be waged on a daily basis – we MUST disobey those who want to charge us fees for not buying FOR-PROFIT health care, for instance…

    Let’s make the LIST of all the other thieving *laws* we need to disobey…who CARES if it gets messier for 400 more billionaires (job creation scam) to be created with OUR *middle class* TAXES….

  28. No matter how many millions of times the maggots decree that fewer dolphins are needed – it is NOT TRUE.

    Didn’t Steve Jobs PROVE to his army of autobot technopsychos that he had all the “best minds on the planet” under his complete computer control?

    And did that lead to a *cure* FOR HIM…? He did get a 25 year old’s liver after the 25 year old miracle-match died in a *tragic* car accident in Tennessee…but that’s about it…

    Crime Inc. is USA’s multi-billion $$$ *health care corporation* – EVERYONE is in on it from hijacking trucks carrying meds to the billing clerks making minimum wage and paying 40% of that out in taxes….

    Lies, hatred, ancient racial revenge, murder – all trickling FROM THE TOP DOWN….and ALL of these newly-revealed on a daily basis, now, are schemes started a decade ago!

    Social engineers aren’t investigating why so much CRIME all got launched at the same time a decade ago?

    Asking their astrologer? Something in the water…? Pawing through *holy books*…?

  29. Agreed with an earlier commenter that you are being too polite!

    “This system has long outlived its usefulness and should be discontinued.”

    Haha you think?! That is some seriously way too quaint wording to describe a laughably corrupt construct that is just one piece of rot among many in our incestuous and dysfunctional financial system! Simon must have his eyes on some high-level job opening at the moment to be talking so diplomatically :)

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