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The heart and soul of banking is supposed to be credit (worthiness) analysis. If bankers and credit investors could be bothered to do their jobs, there would be no need for rating agencies.

Amen!

If you need a credit rating agency to tell you what the risk is on a piece of paper, then you don't want to buy that piece of paper. It really is that simple.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 26th, 2010 at 03:48:12 PM EST
[ Parent ]
But that depends on your alternatives.  It's usually not a choice between buying a piece of paper and doing nothing.  It's usually a choice between buying a piece of paper containing lots of uncertainties, and doing something else (including nothing) also containing lots of uncertainties. The rating agency provides a reference point for checking your own judgments between two or more alternatives.
by santiago on Mon Apr 26th, 2010 at 04:59:15 PM EST
[ Parent ]
You can always cash out.

And at any rate, the people you need to talk to in order to evaluate the risks isn't the bean-counters, it's the engineers. The bean-counters have to rely on the engineers for their uncertainties anyway, so you might as well cut out the middleman.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 26th, 2010 at 05:25:00 PM EST
[ Parent ]
Cash is just another alternative with lots of uncertainties. Look at how exchange rates fluctuate, and how the Chinese bemoan the likely loss of value of their currency reserves when they eventually have change their currency pegs.

You need both, because engineers don't have ways of thinking how the financial world, which is a social model not a physical one.  They just have the hard data and knowledge about how to manipulate and analyze it.  

by santiago on Tue Apr 27th, 2010 at 10:52:49 AM EST
[ Parent ]
You pay for your food in cash, not in Microsoft stock or structured investment vehicles.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 01:14:43 PM EST
[ Parent ]
Quite true, which means that cashing out might be a risk-free option, but only for the very short term.  Anything longer than that and you have to take account of the risk of getting robbed, money losing value, missing out on appreciation that your neighbors are getting, etc. It's likely the case that the risk of holding cash, if you're American, Japanese, or European, is about as high as the risk of holding a US Treasury bond, which can by judged, ideally, against other AAA rated opportunities for securing your wealth.
by santiago on Tue Apr 27th, 2010 at 02:49:17 PM EST
[ Parent ]
You live in the short term.

If you have enough money to worry about it losing value due to inflation, then I really can't get worked up about you losing some of it to the capital market piranhas.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 02:59:57 PM EST
[ Parent ]
Which is why I keep arguing that the credit crisis is mainly a problem for the rich.  But what complicates matters is that social savings also has to invest and save in order to provide for pensions and other benefits, and, like hedge funds for the rich, public pension managers also need to optimize, under time constraints, where and how they secure their members wealth, so they rely heavily analysis of risk such as that provided by rating agencies.
by santiago on Tue Apr 27th, 2010 at 03:15:26 PM EST
[ Parent ]
Which is why I keep arguing that the credit crisis is mainly a problem for the rich.

The credit crisis should have been mainly a problem for the rich. The problem is that the rich are being allowed to strangle the real economy to make up for the shortfall in their fictitious funny-money returns.

As long as you vest political control of the production process with the people who make money, rather than the people who make goods, a crisis in the monetary system will be a problem for the poor.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 10:06:42 PM EST
[ Parent ]
Or just do your own credit analysis. Analysing a simple corporate bond isn't much harder than analysing the stock of said company. Sure, it's pretty hard to figure out what the real value of it is (compared to the market value), but it's a lot easier to evaluate if the company is at a considerable or neglible risk of bankruptcy, which is after all what matters to credit investors as you have no part in the upside.

And if you can't decide what the risk of bankruptcy is because the company has some complex or convoluted business model, don't buy the bond. There are lots of other fishes in the sea.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Tue Apr 27th, 2010 at 05:44:49 AM EST
[ Parent ]
Yes, but that doesn't always help answer the question of whether Bond A, which looks pretty safe by your own detailed analysis, is better or worse than Bond B.  For that, it's valuable to have a comparative standard for the riskiness of assets, which is, really, the only things rating agencies are paid to do.      
by santiago on Tue Apr 27th, 2010 at 02:52:30 PM EST
[ Parent ]
Yes, but that doesn't always help answer the question of whether Bond A, which looks pretty safe by your own detailed analysis, is better or worse than Bond B.

Why do you want to know that? If Bond A is an acceptable investment, then take it. A bird in the hand, and all that...

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 03:02:04 PM EST
[ Parent ]
Because Bond B might be offering a better rate of return. So if it is as safe as Bond A, then that's some evidence that it might be a better place to park your money.
by santiago on Tue Apr 27th, 2010 at 03:09:16 PM EST
[ Parent ]
Possibly. But is it sufficiently better to justify the time and effort to perform due diligence on it?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 03:14:33 PM EST
[ Parent ]
No, probably not, which is why individuals don't usually invest in bonds -- institutions do.  For individuals, cash is probably about as safe as bonds, but for billionaire institutions, including governments and non-profit foundations who have been burned in the credit crisis, holding cash is usually much more expensive compared to holding low-risk bonds.
by santiago on Tue Apr 27th, 2010 at 03:21:34 PM EST
[ Parent ]

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