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Triple-A trouble

Peter Browne is the editor of Inside Story, where the following article first appeared. Webdiary thanks Peter and Inside Story for permission to republish.

Triple-A trouble
by Peter Browne

John Moody, who began publishing investment ratings exactly a hundred years ago, would have been surprised to learn that the company bearing his name, Moody’s, has copped some of the blame – and from some commentators a lot of the blame – for the global financial crisis. Moody started out on Wall Street as a “stamp licker” in 1890, earning $20 a month. After working his way through the ranks he went out on his own, publishing industry guides and a monthly magazine for investors. But it was only after the downturn of 1907, which forced him to sell his company and start again, that he came up with the idea of rating and analysing the riskiness of the investment opportunities offered by individual companies – an activity that has come to have so much influence not only over business but also over economic policy.

As the dust settles on a dramatic eighteen months for the international economy, the credit rating agencies continue to attract criticism from the likeliest and unlikeliest of quarters. In his new book, The 86 Biggest Lies on Wall Street, the former investment banker John R. Talbott writes: “Of all the criminal behaviour conducted by all the criminal participants in the schemes and scams that created the global credit crisis, I believe the most egregious was that conducted for profit by the rating agencies.” Last month in the New York Times the economist Paul Krugman again criticised the agencies, “whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.” Even the senior Republican on the House of Representatives subcommittee on capital markets, Scott Garrett, concedes that “they didn’t do a great job” and might need more supervision.

For people outside the finance industry, the growing reach and power of agencies that put a rating – from AAA to D, with D conveniently standing for default – on the bonds issued by borrowers can be puzzling. A century after Moody’s first set of ratings, the industry is dominated by three companies – Moody’s, Standard & Poor’s and, to a much lesser extent, the French-owned Fitch Ratings – with a combined annual turnover of around $US6 billion. These three big players, along with a larger group of much smaller agencies, rate the risk associated with lending not only to companies but also to governments and public agencies, from Queensland to Botswana. Despite the emergence of rating agencies in individual countries and regions, the big three, and especially Moody’s and S&P, have cemented their dominance in recent years.

The turning point came in the 1970s. For the previous four decades the agencies had been a semi-formal part of the regulatory system in the United States, recognised in state legislation as arbiters of safe investments. They were private organisations, but in a country often suspicious of government regulation they took on some of the characteristics of public agencies. As Timothy Sinclair describes in his 2005 book, The New Masters of Capital, this role was reinforced in 1975 when the US Securities and Exchange Commission nominated Moody’s, S&P and Fitch to a new category – nationally recognised statistical rating agencies, or NRSROs – whose imprimatur guaranteed preferential treatment for the borrower’s bonds under federal regulations. At a stroke, the three agencies were not only locked in as key players in the regulatory system but were also protected from smaller competitors who hadn’t been given the nod by the SEC.

Meanwhile, the finance industry was developing increasingly complex financial instruments – derivatives and structured financings, for example – which gave the agencies a much more important role in helping investors decide between alternative options. Companies were less likely to seek funding from banks, and banks were facing stiffer competition for depositors’ funds. Not surprisingly, the banks themselves started seeking financial holdings that could increase their profits, and they sought them in a globalised financial world.

The impact of these factors on the size and profitability of the agencies could hardly have been greater. In the mid 1960s, according to one writer, S&P’s sole office, in New York, had “three full-time analysts, one old-timer who worked on a part-time basis, a statistical assistant, and a secretary…” Twenty years later the company employed 225 analysts and was operating branches in Tokyo and London. And another twenty years on, the two biggest agencies had between them around thirty offices, mainly in the United States but also on every continent except Africa. (In Australia, Moody’s set up in Sydney in 1988 and S&P in Melbourne in 1990; the Age’s Ruth Williams reports that they now have about sixty and about 130 employees respectively in Australia, with Fitch’s newer Australian operation employing twenty-three.)

The other important factor driving growth was a change in the way the agencies charge for their services. Once, they earned money mainly by selling detailed reports with sometimes very detailed titles (John Moody’s first report was called Moody’s Analyses of Railroad Investments Containing in Detailed Form an Expert Comparative Analysis of Each of the Railroad Systems of the United States, with Careful Deductions Enabling the Banker and Investor to Ascertain the True Values of Securities by a Method Based on Scientific Principles). But from the late 1960s, the agencies increasingly charged the issuer of the bonds – the borrower – for assessing their capacity to pay back a loan.

This sounds a lot like a recipe for a conflict of interest, and it has certainly been the most common criticism made of the agencies over the past year. The borrower, who pays the rating agency, naturally wants to attract lenders. The agency is working for the borrower, so surely it has an incentive to talk down the possibility that the borrower mightn’t be able to repay? But the agencies respond that they won’t last long in the business if they keep boosting the virtues of the companies paying them: a default will reflect very badly on whoever that gave them a high score, so there’s a built-in bias towards caution. This argument had some force – at least until the subprime crisis showed that the agencies could all get things very wrong, in a very incautious manner, for a long time without being called to account.

But there’s also evidence that the problem is not so much that the agencies are talking up their clients but that they are boosting a certain view of how business and the economy work, or should work. The agencies’ ratings reflect the mainstream of thinking among businesses, banking economists and the pundits who dominate the popular end of the business media. In this world, the long boom that began in the late 1980s, and was only briefly interrupted by the Asian economic meltdown and the dotcom crash, looked set to continue forever. This was a “weightless economy” in which the marginal cost of producing the newest and most exciting products – delivered by the internet – was close to zero, so the old constraints on growth no longer applied. Fuelled by innovation, low interest rates and interesting new types of finance, western economies would keep expanding. Debt could always be repaid; housing bubbles would never burst. Above all, governments should leave wealth creation to the markets.

Even when the subprime market began to deteriorate, the agencies clung to their optimistic ratings. Only when the writing was clearly on the wall did they dramatically downgrade the funds, and by then it was far too late.

The flipside of the agencies’ enthusiasm for an unbridled private sector is a distinct bias against the public sector – despite the fact that federal, state and local governments and public agencies, even in Australia, are among their clients (and bore some of the fallout from the subprime crisis). As the Australian economist John Quiggin observes: “State and local governments, which rarely default on their debt, are assessed far more stringently than corporate issuers… One effect of the differential ratings practices of the agencies is that government borrowers have been forced to seek insurance from bond insurance companies such as AMBAC that are, in reality, less sound than the governments they are insuring.”

The suspicion that the agencies don’t like government spending was given a boost in Australia during the late 1980s and early 1990s. In a series of controversial cases, agencies downgraded governments primarily on the basis that they were running high budget deficits or carrying what was considered too much debt. No one could honestly have believed that those governments had become more likely to default on their debts – which is what a credit downgrading is supposed to signal – so the agencies’ conscious or unconscious motivation must have been to pull these governments back into line with the prevailing business orthodoxy. The most dramatic rating decision involved the incoming Kennett government in Victoria. Conveniently for a government set on cutbacks, a two-notch downgrading came just before the new treasurer’s first budget, adding to a sense that the state finances were in crisis. Government spending on health, education and other programs was slashed, and Moody’s and S&P obliged by upgrading the state.

Paradoxically, the agencies can – in one sense at least – be very conservative organisations. Their primary function is to judge a company (or a government) on the basis of its ability to repay bondholders in the relatively near future. But, as Sinclair describes in his book, the agencies are increasingly faced with grading projects and organisations – ambitious telecommunications projects, for example – that would once have been financed directly by government or predominantly by shareholders with a view to the longer term. On top of that, they are often attempting to attach a grade, at a single point in time, to businesses operating in a complex and fast-moving environment in which returns sometimes don’t materialise in the short to medium term. In that sense, they could have contributed to the short-term thinking that eventually produced the subprime crisis.

Unchastened by their recent failures, the agencies are still pressuring governments to toe the line. In May, the Wall Street Journal reported, “Britain was warned by Standard & Poor’s Ratings Service that it may lose its coveted triple-A credit rating, triggering a drop in UK bonds… The warning – marking the first time the UK’s top rating has come under threat since S&P began assessing it in 1978 – is another blow for Prime Minister Gordon Brown ahead of elections to take place by June 2010.”

It’s the agencies’ worldview that makes changing the system so difficult. They are quite happy to concede the need for more “transparency” and a degree of greater competition, but it’s hard to imagine any major shift in the weight of opinion they express. The British government has been a leading exponent of the need for governments to stimulate the ailing world economy – a strategy that has won fairly wide, though not universal, support – but the agencies still believe that their view of government debt is the right one. The agencies have been under intense scrutiny before – many mainstream economists now accept that they contributed to the depth and duration of the Asian economic crisis, for instance – and have largely escaped change. The intense criticism during the Enron scandal did force the Securities and Exchange Commission to open up the system a little by giving more agencies NRSRO status, but not surprisingly the big three, with their long head start, continued to dominate.

Over the past year more significant options for reform have been discussed in Europe, North America and Australia. Europe has taken the running, adopting the tightest set of regulations. Agencies operating in European Union countries must now register with the Committee of European Securities Regulators, and must disclose their methods and make clear when they are rating “complex products” like those that precipitated the subprime crisis. Agencies will also be required to publish annual transparency reports and – importantly – to have at least two directors on their boards whose salary does not depend on the agency’s business performance. Agencies must also institute an ongoing internal review of the quality of their ratings and no longer provide financial advisory services alongside their ratings function.

All that seems pretty clear, though whether it will shift the industry-wide worldview is another question. What’s nowhere near as clear is what the United States will do, and what that means for the European regulations. “After proposing some radical and promising reforms of the regulation of the ratings industry, the Securities and Exchange Commission settled in December on the two least consequential and least controversial proposals,” says Richard Herring, Professor of Finance in the Wharton Financial Institutions Center at the University of Pennsylvania. These two new rules separate consulting from rating and prohibit rating agencies from accepting gifts worth $25 or more from their clients

President Obama’s proposals were not much tougher, according to Eric Dash, banking writer with the New York Times. “While the administration is proposing some modest changes, none addresses what many see as the central problem: Services like Moody’s and Standard & Poor’s are paid by the companies whose securities they are evaluating. It is as if Hollywood studios paid movie critics to review their would-be blockbusters,” he wrote last month. “Many of the proposals… are vague principles or paper standards that go little beyond changes being contemplated by the Securities and Exchange Commission, or even the rating agencies themselves.”

The White House proposals did include a call for regulators to stop relying so heavily on assessments by the agencies, and Congress – via a number of committees – is looking at a further move away from this quasi-regulatory role, together with other proposals for change. But the legislative process could be protracted and there’s a strong chance that the options will be diluted. Australia, meanwhile, will now insist that agencies obtain a financial services licence, bringing them under regulatory scrutiny, and conform to a code of conduct developed by the International Organization of Securities Commissions, or IOSCO, which is less stringent than the new European rules.

According to Timothy Sinclair, there’s no reason to think that rating agencies will be less important in future. Complex financial arrangements will inevitably be more widespread, and the agencies’ business model is unlikely to change, which means that issuers of bonds will still overwhelmingly foot the bill.

“If there is a substantive change to come out of the crisis,” he told me by email, “it may come in forcing the agencies to play the game they were initially founded to play: judge. The problem was that in working on securitised finance the agencies stopped playing this role and started helping financial players create financial instruments.”

The IOSCO code of conduct certainly stresses the need for agencies to be rigorous and independent in their judgements. As Sinclair puts it, “agencies must play a much more conservative game – like all market actors really. This might lead to the development of new institutions as securitised finance is a creature of ratings. It only exists because of the different categories of risk. So there may be an opportunity here for a lot of ex–rating agency officials to establish advisory firms.”

If the regulations eventually adopted by the United States are significantly out of step with Europe, then the chance of breaking the stranglehold of the US-based agencies could be lost. Europe might bolster some of its own agencies, and the big three will have to adhere to the European rules when they’re working out of their European offices, but it’s likely that the rest of the world will be directly or indirectly subject to the American regulations, and hence to the influence of the two giant American agencies.

This means that people like Bill English, New Zealand’s finance minister, will probably continue to frame national budgets – as he did just six weeks ago – with one eye on the rating agencies. As the NZ media reported at the time, government ministers met with S&P analysts in the week before the budget, apparently as part of a successful campaign to head off a downgrade. The agencies would no doubt argue that their intervention – or threatened intervention – helped the government make a difficult but necessary decision. Some New Zealanders might wonder to whom their elected government feels accountable.

Not everyone is in the thrall of the agencies. In February this year, a few days before she planned to announce the state election, the Queensland premier Anna Bligh received the news that S&P had downgraded Queensland’s credit rating. Five months and one election later, Bligh is still premier. This suggests that governments might not always be taking the riskier course when they ignore or stand up to the agencies – something that governments all over the world might consider when they’re next faced by a threatened downgrade.

John Moody lived to see his company prosper through almost half a century. He died in 1958, aged eighty-nine, having become a “strong advocate of Christian principles in business.” It’s interesting to speculate about what he would have thought of the role of his agency just a half-century later.


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The cons of this century come think and fast

PC Moffat "Finally, could this carbon trade (cap and trade or whatever they decide) thing be the next big boom."

It's possible (a lot of people hope to earn something for nothing), however highly improbable. That's not to say scepticism isn't very healthy regarding this.

Interestingly this particular industry has recently witnessed a boom. It was largely located on the American West Coast (California) so it may have been missed. The bust hasn't been missed.

Alternative energy just doesn't tick the right investing boxes. If one wants high risk/return, one is better suited to bio-tech. Investment can be limited with the possibility (that's all it is) of unlimited returns. Energy is large up-front costs, and a limited mostly regulated return. It's a dog for all except the biggest.

Is there money in carbon trading? Is there money in say Disney Dollars? Personally, I don't see bond traders scrambling for the "carbon trading desk".

You mentioned the tech boom, so you'd be well aware there's a big difference between theoretical value and money in the bank. Third World nations should take a very careful note: A percentage of nothing still equals nothing.

The only way an alternative energy company can show a profit is through subsidy. All oil majors have invested billions into such alternative schemes, and proved that point.

That's right, Mr Taxpayer wears the burden. Even then governments will no doubt be paying for what hasn't been conjured up. No company will build such things without minimum guarantees on returns. And they can ask for them, and no doubt will.

And who will be these "new" energy companies? Well, the same ones that supply it today, they're the only ones big enough. I guess someone will be getting a taxpayer gifted pay rise.

This whole pointless excercise is a tax, it will only ever be a tax, and a tax that won't achieve what its set up to achieve. Alternative tax-cuts in other areas will nullify the draconian "luxury" crackdown. The pity is that the poorest will wear the burden (no income, capital, business tax cuts for them) for this total abasement of responsible government.

Those that embrace it today will have long since run from it when the consequences become clear for all to see.

Isn't this theft?

It appears (Investors seek $25bn rescue) that there are calls to take my money (what I pay in taxes for public services) and use it to pay out property speculators so that they don't need to take losses.

It's all dressed up in fancy words - retirees with nest eggs, funds frozen because of government action etc etc. But the bottom line is that investment is tied to risk and high return is tied to high risk. Some of these investments are now in trouble, likely after making a lot of money in good times.

I do care for people undergoing hardship. That is why I pay taxes for Centrelink and health and other subsidies. This money won't mostly go to go to these people; mostly, it's going to go to people living in luxury homes and working in air conditioned offices.

If my money was being responsibly invested into the the real economy, then maybe yes. But propping up the property bubble really does not make sense. Yes, property bursting will cause a blip to the real economy, but it will subsequently allow the real economy to channel money into productivity rather than waste it on rents. The property bubble needs to burst if the real economy is to get back on its feet. 

Economic fallacies and straight cons

PC Moffat "This current financial crises has been the creation of easy money; artificially low interest rates married with business models that relied on eternal growth for their success".

"Real" economic growth is the most misunderstood of beasts. If money is neutral (supply is the problem here) there isn't anything wrong with "eternal growth", in fact, it's all good. It can only come about through productivity gains, innovation, supply and demand etc. It's the reason we don't send guys down a mine with canaries, the reason we no longer write with quill pens, and the reason all illness isn't treated with say leeches.

The biggest fallacy is that the Great Depression was caused by a market crash, it wasn't. The belief in this fallacy naturally means that any up market is the end to any depression/recession, it isn't. How's things at the moment? Employment increasing is it? That's the only question that should be asked.

This carbon tax thing has an odour about it. But at the end of the day that's what taxpayers are for, to take care of the boys club.

Of course it has a smell about it, it's a con. It's the "too big to fail tax" or "too small to succeed tax". The money through a flat tax goes into a large government pot. It's then distributed as the "particular government at the time" will see fit. And as you know my man, there's a lot of debt to be paid. And tax cuts are always on the way - politicians do need to be elected.

A man that drives a luxury car doesn't concern himself about gasoline prices. A man that lives in a fourteen bedroom house doesn't concern himself about the cost of electricity. The man that doesn't probably does.

The point for industry is even worse. Who would invest in an up and coming job supplying business, when one can invest in a "too big to fail" business? When one wins, one wins. When one loses, one still wins. Great work if one can get it.

The average Joe on Main Street is destroying himself for the benefit of those on K Street and Wall Street. They should never, not one of them, agree to this tax. It's a blatant robbery of not only them but their children, and their children's children etc.

Good capitalism is built on risk and reward, not just reward. Helicopter Ben and assorted Wall Street Socialists have taken away the risk part. Capitalism cannot survive without both in the equation. People will eventually see this (losing lifestyle is a great teacher), again, the only factor is time.

Too small to care for

Paul M; I guess what you are saying is that slow and steady wins the race. Flooding the market with easy cash quickly causes market distortions, something created by the central banks. The market will eventually correct such inefficient distortions and invest in real (efficient) production (and profit) and less risk.

But as you mention at this point in our economic history it would appear, no it is a fact, that some businesses (mostly banks) are too big to fail, thus the elimination of risk.  This in itself can only create distortions or investment mismatches. Why risk your cash in the real world of capitalism and considered investment when your investment can be underwritten by the tax payer?  This mini boom is an example of investors recapitalising the big US banks, not the manufacturing and productive sectors which would create stuff for export, thus improve the national debt.

Could this mini boom be an example of the market being both right and wrong at the same time?  Right because the investor is keeping his cash safe, and wrong because those investments are in businesses with unsustainable business models underwritten by the taxpayer. No risk. It will be interesting to see how the market behaves; at the end of the day, as always, it will be a matter of timing. And timing is everything, a luxury the boys club enjoy to the max.

You mention that the 1929 stock market crash did not cause the Depression. Like Paul Walter I am a babe in the woods with this economic stuff but I have read a little bit about the Depression and like all things economic I simply don't know what to believe. I work with the basics; like if your income is shrinking and your debts keep growing then things will get ugly. Sooner for an individual and later for a nation, but the end result is the same: bankruptcy.

It is interesting, however, that there was a severe and rapid recession in the US in 1920/21. There was also an equally rapid recovery:

"Historian, Thomas Woods argues that the massive 1921 recession and subsequent rapid recovery is an episode in the history of capitalism and economics that is woefully understudied. He believes it to be a watershed case proving that free markets adjust prices and supplies much more efficiently than any government coordinated action, and that Keynesian philosophy ignores the '21 episode because it suggests government intervention is not required in such "crises.""

At the end of the day economics is not a science, just an attempt to understand the behaviour of commercial interaction and it social and economic consequences. No two economic events are identical, as such an experiment can never be repeated; at best we can identify trends, some of which you have pointed out.

Finally, could this carbon trade (cap and trade or whatever they decide) thing be the next big boom. It keeps getting curious but one thing for sure the boys club are setting themselves up on a winner. Pity about the rest of us who are too small to care for. 

To put an end to this cap-and-trade fiasco, the only option is probably to cap all the “revolving door” stooges and trade them out for oil and coal execs. But unfortunately, Shooters, that won’t be the fate of cap and trade. Not if the U.S. Climate Action Partnership (USCAP) can help it!


When you ask who’s the biggest winner if the bill goes through, you’ll find the Chicago Climate Exchange (CCX), co-founded by Hank Paulson and Al Gore. Members include Amtrak, DuPont, Ford, Oakland, Chicago, and the Iowa Farm Bureau.

The whole idea is the brainchild of Richard Sandor — aka “Mr. Derivative.” ...."

Here we go again.

And Paul mate if anything of the above is wrong, then I'm sure you will agree it is also right ;-)


Cheers PM

Deluded, me? My problem is that I wish I were

Fiona Reynolds "Thank you Phil for an excellent analysis. I never cease to be amazed by the capacity of some people, such as Paul Morrella, for self-delusion and their reification - if not deification - of THE MARKET".

And I'm always astounded how people can only see what they want to see.

We (the world) don't and never have had a "free market". Wall Street socialism may be greed but it's not a free market. The brainwashed belief that greed equates to free is the reason this delusion persists. That's the great delusion. The scam etc. And Main Street is it's greatest follower.

A free market would mean Andrew Hall (oil trader for Citi) would be just another guy in a liquidation queue (the same as any other employee of a broken business). Instead he's now going to be adding one hundred million to his art collection.

The world's great and wise democratic leaders (not free marketeers) told you they saved you from a depression. As Andrew Hall (thank you Barrack) so aptly proves: some depressions are worse than others.

The world is why it is because that's what people really want. Every action or non-action proves so much more than words. It always will.

Globalisation and Deregulation date....

And I'm always astounded how people can only see what they want to see.

I don't know why that would be Mr Morrella, you and I do that each day. A denial would make you the only completely rational person on Earth. But that might tend to philosophy and you, resolutely,  traipse towards the resolutley practical.

All of which stated, I do agree:  if the last three years have demonstrated anything it is that "the market" is as fucked as any other human "institution". And institution it is as the Howard Government will attest: the "market" was a cornerstone of its "economic" policy (had difficulty deciding whether to apply the inverted commas to one or both words).

There never has and there never will be a free market. Political interests will always see to that - no matter the mealy-mouthed clap-trap. Entrenched interests - increasingly "transnational" - back those interests as they see fit. 

"Globalisation", on a good night out with deregulation,  has conceived of a child. Unfortunately we are all now paying for its cesarean. My children will live with it.

Father Park

Mea Culpa (help!!)

Well, all I can say is, after reading these exchanges, is that wires may be crossed -  fundamentally, the same doubts are being expressed, but expressed in different ways. It's more about semantics and emphasis. Is the problem that the vehicle drives somewhere or not,  because it is or not engaged the right way, say, or because it produces too much pollution, or because it is taking the wrong or right people to the right or wrong place at the expense or to the benefit of others? Etc, etc.

It's like, if the goose is producing manure rather than golden eggs, what is the significance of this? What seems alarming and disappointing may be only a natural part of an obscured wider process and beauty being in the eye of the beholder, maybe some have to modify, upwards or downward, their expectations.

As to the workings and  the mechanism, we come back to conflict over what the purpose and meaning of the system is; what it meant to do, for whom. 

All this goose-shit is pretty natural and to many farmers, may be of  more value than gold. The underlying theoretical system is ok, even if the current workings are questionable thru too many or too few (ideological?) bolt-ons.

The system is a wider, deeper, broader thing that incorporates many aspects of human desire over time and space that any individual cannot hope to understand fully?

Ok, that's life. And all the modelling itself is thus contingent, as we have found out over the last couple of years - not least because command elements within the system have themselves  perhaps deliberately obscured the information others also need to make informed life decisons?

So there is the system, we can do a detached analysis and suggest that that's just the way it works and not pass value judgements.

Or we can suggest that the system is something history has been imposing on reality (or vice versa!), which allows us to open on speculation as to what the goals of an economic system operating within reality ought to be doing - a mechanism for changing reality.

Then we include value judgements.

Is Wall St a "socialism" or not depending on what a given individual might feel to be their own interests or entitlements. Or, is the system a "capitalism" amenable to "improvement" on the basis of a notion that it can be improved to allow for the greater happiness for more people (is this itself a valid question, formed depending on character and outlook), rather than a form of reality that is a test that allows the wisest to survive best and is a fair thing without a redistributive or directed component, relative to "efficiency" (in what sense??)

Look, to tell the truth I blanched at this thread when I first scanned it - nothing makes me feel so inadequate as a discussion on economics and pol-economy.

John Quiggin is mentioned in the thread, he tries to explain exactly these things at his blog also, but the jargon frightens me off. Well, not this time. I must bite the bullet; grasp the nettle, altho it does look suspiciously like hard work, for a tyro.

But coming back, I found a number of heroic contributions from all participants so far, and because I seek better an understanding myself, I am hoping others will react to my presence not with scorn at my ignorance, but in the realisation that I see the thread as itself processive.

Call me what you like, but please keep explaining different aspects of economics and pol economics. I'll put up with the probably deserved scorn, but please give my mind something to work with, because the whole thing looks like a mare's nest, just at the moment. But it also looks like a jigsaw puzzle that can be put together over time.

As I asked above, is it because some of the terminology is so open-ended?

Please, all of you, keep contributing!!

Damn right

PC Moffat, how is the market all knowing? The market is all knowing because at any given point in time, it's always right, even when it's wrong.

The lost land of economic broken dreams has, and will always exist, to prove my point.  

Thanks Paul Morrella

Thanks Paul, I must admit I felt a little confused having read your earlier post; now that you have explained things I am not confused at all.

Debt and what to expect...

This 10 minute clip is worth watching. Michael Hudson outlines the US economy, the boys club and debt peonage.

The world's 5th largest economy, California, may be an indication what the US citizen has instore. California spending cuts spark fury:

“We think this is grave,” said Frank Mecca, executive director of the County Welfare Directors Association of California. “Cuts of this magnitude undo what we think is 70 years of successful policy. We’re talking about 100,000 children whose parents aren’t going to work. Tens of thousands of kids are going to go on waiting lists to get healthcare . . . large numbers of people [will] end up in nursing homes.”

As the saying goes: "As goes California so does the rest of the nation."

For what it's worth

Thank you Phil for an excellent analysis. I never cease to be amazed by the capacity of some people, such as Paul Morrella, for self-delusion and their reification - if not deification - of THE MARKET.

I would strongly suggest to all the unreconstructed libertarians out there to read and think about the implications of a piece I published a few weeks ago - The death of macho. Or does that suggest too much of a threat to certain portions of your anatomy?

My opinion

Jay Somasundaram: "Paul, could you please explain, in some detail and with evidence from previous cycles why you believe that central banks create the cycle? Do other economists espouse this view? I can't recall coming across this theory before."

I'm not going to link economists, evidence or anything else. And I'm not going to post pages of economic jargon and data on this site. My opinion is clear, people can choose to agree or not. My opinion isn't going to change, and I don't feel a need (long past it) to attempt to change others.

Central banks (they vary on size and importance) control (at this point) monetary policy (money supply) (find out what monetary policy is if there is a need).

Under the present system, money supply is either too loose or it's too tight. What's the perfect equilibrium at a moment in time? I don't know, and neither does anyone else. That's the point.

Markets, for example, estimate (guess if you prefer) the future whilst economic data tells us the past. The crystal ball is only in fairy tales. The greatest trader will at best get only sixty percent of trades right (money management is the key to trading success). What hope anyone else?

When supply is too loose, an excess of money is in the system. This devalues money the same as any other commodity (more is worth less). More therefore is needed just to hold on to the present standard of living. Over time this will lead more and more toward a race for higher and higher returns. Eventually leading to a misallocation of resources (a bubble). Eventually this misallocation must be addressed (like an unhealthy lifestyle). It is addressed either naturally (it breaks down) or it's forced by other factors (cutting supply).

The bursting of any bubble is followed by a period of re-adjustment (liquidation of misallocation). This period is known as a recession etc. And under our present system the cycle begins a repeat. It always will repeat. A perfect equaliberium simply cannot exist with undue outside influence.

PS The present lunatic "Helicoptor Ben" (he throws cash from them) and without doubt the most stupid Congress ever, have gone way above and beyond. Together they have created (it's not part of "helicoptor's" impossible job description) such outrageous distortions that it can only end in much worse than tears. There is like it or hate it a natural economic order of things. That order will come about come rain, hail or shine. The only factor is time.

PSS look at the greatest booms of the past. Every single one (bar none) was preceded by a large jump in supply and the bust a contraction. The next boom-bust won't be any different.

Rating the United States of Debt

Paul Morrella: If "the market" is all knowing why then is "the market devoid from main street reality"?

Or is the market running on emotion and manipulation? Best leave that one to the speculators and insiders.

A few days ago Andy Kessler wrote in Wall Street Journal: "Was it a Sucker's Rally"

"On March 18, the Federal Reserve announced it would purchase up to $300 billion of long-term bonds as well as $750 billion of mortgage-backed securities. Of all the Fed's moves, this "quantitative easing" gets money into the economy the fastest -- basically by cranking the handle of the printing press and flooding the market with dollars (in reality, with additional bank credit). Since these dollars are not going into home building, coal-fired electric plants or auto factories, they end up in the stock market.

A rising market means that banks are able to raise much-needed equity from private money funds instead of from the feds. .....It's almost as if someone engineered a stock-market rally to entice private investors to fund the banks rather than taxpayers."


This current financial crises has been the creation of easy money; artificially low interest rates married with business models that relied on eternal growth for their success. Something the ratings agencies didn't factor in when analysing those sophisticated and complex debt instruments created by the very clever backroom boys whose knowledge of the real world extends to mathematics and computer games.

The ratings agencies failed badly and should be taken to task, in the legal sense, but that won't happen. It's a boys club and we all know it.

The ratings agencies, especially the chosen few, have a lot to answer for but so does the treasury,The Fed and the Wall Street banks who run the show. And that is the problem, Wall Street pretty well runs the whole damn US government. Barrack Obama is a paid up member of the boys club; something that has now become somewhat obvious. Not only has the US citizenry been democratically abused it has, no control whatsoever over their money supply. That is in the hands of the chosen few and has been since 1913.

Jay Somasundaram asks Paul about the role of central banks in creating boom and bust cycles. Jay, I think Paul is referring to the Austrian economists, such as Hayak, and especially the role the US central bank, commonly known as The Fed, has played in earlier cycles including the current one.

Firstly The Fed is not a US government organisation; it is a privately run boys club where the share holders are among the biggest Wall Street banks. How's that, a bunch of rich pricks get to pick the winners, themselves. And they don't even get audited, although a bill has been recently introduced to change that. The boys at The Fed are shitting themselves for if audited they will have to explain stuff they would rather we all didn't know. The boys club will find a way to kill the bill, they can afford to, besides they own the government; they are the government.

It is a fact that since The Fed was created the purchasing power of the US dollar has been reduced by around 96%. Since then the US total national debt has grown to over 11 trillion dollars with estimates it will soon grow to 17 trillion as Obama tries to re-inflate the economy (addicted to debt?); none of this debt gets repaid only the interest. The dollar soon or later will be under real pressure and the US bankers (China etc.) are concerned to say the least.

11 trillion dollars is a lot of cash and there is no way the US could honour that debt if the markers were called in. At best all they can do is service the debt by auctioning new bonds to meet interest payments on the principle. A ponzi scheme?

So far The Fed has looked after itself and the club pretty well. Each time they create money (which reduces the dollar's value) it is the banks who get to use the newly created money first. Banks use this money to invest in (loan) and purchase assets at their un-inflated value. When the newly created money eventually flows through the economy it loses value and stuff costs more; a pretty good earner for the banks; just as it was meant to be. And don't forget - as the market value of an asset increases the bank's balance sheet looks healthier and enhances its ability to issue more loans.

If one wishes to sell their home they will only get what someone else is willing to pay for it; that is how the market works. But not for the boys club for as the above quote states The Fed is buying financial crap that no one else wants; worthless or almost worthless securities that if valued at the market rate most Wall Street banks would be insolvent. The boys club simply swapped slums for mansions at the taxpayers expense.

The Austrians argue that by keeping interest rates low (for too long) and creating a wash of easy credit (across the whole economy) entrepreneurs end up using their capital and credit recklessly and eventually the market reckons the good from the bad investments/companies.

At the end of the day a company has to make a profit, and enough profit to service any debts and future liabilities. In short a company has to produce wealth in a sound and practical manner. The markets had to re-learn this back in the dot.com days when companies producing absolutely nothing at all had huge share values and no earnings. It all ended as expected, if you don't produce, you don't make a profit, no profits, no dividends, no investors; all else is speculation.

The efficient entrepreneurs will survive a bust and cannibalise their reckless competitors, the industry sector will stabilise and so the cycle continues. In short the central bank can create an economic environment which amplifies business activity to unrealistic and reckless levels; those halcyon days and all that.

If we look at the current financial crises it would be hard to disregard the views of the Austrian economists.

The privately owned US Federal Reserve Bank (and the power elite) have pretty well stuffed the dollar as a currency, at the moment it is only faith (and global necessity) that keeps the dollar afloat. Let's have a look at the numbers:

The US has a current national debt of over 11 trillion dollars and growing rapidly; the 2009 budget deficit is 1.84 trillion dollars; how are they going to pay for this?

The US has to sell the debt by issuing bonds and other US denominated paper, but who is buying, especially at the interest rates offered?

Currently the US's major banker has been doing a pretty good job with underwriting the US economy by buying US debt. You will note that Hillary Clinton and Tim Geithner (ex-Goldman Sacks now head G man with the treasury, a member of the boys club) have been reassuring the Chinese that all is on track and to keep faith in the US fiat currency. And it is a fiat currency for it is only goodwill that underwrites it; the goodwill of the US taxpayer, not gold nor silver or a dead rat in a drain pipe.

Currently there are not too many nations flush with cash and those that have cash are becoming increasing wary of the US's ability to offer a reasonable and safe return on their investments - in the US taxpayer.

China currently holds around $2.13 trillion in foreign reserves, 70% of which are in US dollar assets. This year the US needs $1.84 trillion dollars to cover a budget of $3.45 trillion. Even if the Chinese lent all of their reserves to the US then it would only keep them out of the shit for the current fiscal year. And the Chinese are not going to do that, so where will all that cash come from, to both service the growing national debt and the current budget?

According to the Wall Street Journal on 31 July 2009:

"Shaky auctions of Treasury notes this week reignited concerns about whether the government can attract buyers from China and elsewhere to soak up trillions in new debt.

A fuse was lit this week when traders noted China's apparent absence from direct participation in two Treasury bond auctions. While China may have bought Treasurys just before the auctions, market participants read the country's actions as a worrying sign that China and other foreign investors may be ratcheting back purchases at a time when the U.S. is seeking to fund a $1.8 trillion budget deficit.

This week alone, the U.S. deluged the bond market with more than $200 billion in record-size sales. The U.S. has had little trouble finding buyers in recent months. But that demand is fading, and the Treasury market has become volatile."

The Chinese are concerned that low interest rates, Obama's stimulus and the inability of the US to regain global stability will end with the US having to print even more money, thus further debasing the currency and eroding China's investment.

Don't be surprised if the Chinese offer the US Yuan bonds, there has been rumours of such. Wall Mart has just started selling 5 year “Samurai bonds” (Yen denominated paper) out of its Japanese operations, a trend that will probably grow as time goes by.

At the end of the day the US taxpayer is going to have to come to terms with the fact that the power elite, that oligarchy of business and legislative sluts (the boys club) have pretty well stuffed the US currency.

If the US cannot lift interest rates (to attract investment of bonds etc.) for fear of creating a full blown depression (which it probably will) and if the tax base is shrinking, which it is, then how will the US service their debt without printing lots of paper and dramatically devaluing the dollar ?

US taxpayers are going to have to foot the bill for this financial orgy, they will lose benefits, homes, and they will be taxed (regressively) to pay for the sins of the boys club. This carbon tax thing has an odour about it. But at the end of the day that's what taxpayers are for, to take care of the boys club.

Looking at current numbers the day of reckoning is not far off for the US dollar, and the US taxpayer; they are broke. It looks like the boys club have absolutely no intention to change its destructive and selfish behaviour so we can expect lots more conflict, oppression and social disruption; and the usual bullshit from the boys club.

Maybe the US taxpayer should blow The Fed up; they would probably being doing themselves a favour.

The market is all knowing

The boom-bust cycle is created by the world's central banks, nobody else. The rest is just noise. They (central banks) play the drum, and everyone dances to the tune. That the lesson has failed to be learned means that we undoubtedly will repeat the cycle. The role of the current central banking system is a role bound for systemic failure. Always has been, always will be.

Every boom has its genesis in the preceding bust. The current market "mini-boom" isn't any different (and we still have crazy August yet to come). Two things stand out for me:

1. How devoid from main street reality market prices are.

2. American savings rates are increasing (the first time in God knows when and contrary to popular opinion, and all attempts by the current economic illiterates, it's a good thing for America). I believe we're seeing the credit bubble exported to Asia. It'll have consequences down the road. And of course nobody "saw it coming".

It would be a nice world if as the writer believes political parties make a difference in this current game (goodies and baddies). They don't.


Paul, could you please explain, in some detail and with evidence from previous cycles why you believe that central banks create the cycle? Do other economists espouse this view? I can't recall coming across this theory before.


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