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Quite true, but often it comes down to a trade off between trust and worst quality data.  If you believe that your counter-party in a deal has an incentive to withhold some of the great data they have from you in strategic ways, then it's probably a good idea to just assume they are withholding key data. A somewhat more independent appraiser, even if flawed, is likely to be better than the one you must assume, a priori, is lying to you.
by santiago on Mon Apr 26th, 2010 at 04:51:03 PM EST
[ Parent ]
If you're not allowed to see the underlying data, you don't buy the piece of paper. If they don't show you all the data you need, they are either lying or incompetent at data collection, and you don't buy the piece of paper.

Seems simple enough.

(Yeah, that would kill the entire securitisation market dead. That is a feature, not a bug.)

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 26th, 2010 at 05:30:10 PM EST
[ Parent ]
Yeah, it's called due diligence...

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Mon Apr 26th, 2010 at 05:42:10 PM EST
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But due diligence is not what rating agencies do.  It's what investors are supposed to do. Rating agencies are just supposed to predict the odds of default relative to alternative investments, assuming that what they've been informed about underlying collateral is true, which is just one piece of due diligence that a responsible investor is supposed to take into account.  
by santiago on Tue Apr 27th, 2010 at 10:37:23 AM EST
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But due diligence is not what rating agencies do.

Well, that's quite clearly true.

Whether they should have been doing it is, hopefully, something that will be decided in the course of a fair an honest criminal trial.

Rating agencies are just supposed to predict the odds of default relative to alternative investments, assuming that what they've been informed about underlying collateral is true,

Then rating agencies are worth fuck all, if you'll excuse my French.

You need to see the underlying data to determine whether it is plausible. If the rating agencies are permitted to take the truth of the underlying data as read, then the investor still has to perform an independent analysis of the data. And once you're looking at the data yourself anyway, you might as well run the full battery of tests.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 10:43:15 AM EST
[ Parent ]
I agree completely. Rating agencies aren't worth much by themselves, so the idea propogated in Basel or in current policy reforms that we can regulate risk by fixing it somehow to the judgments of analysts at leading rating agencies is inherently flawed. Basic due diligence means that investors themselves should have their own look a things before they buy, regardless of what third party bookmakers might opine about odds.
by santiago on Tue Apr 27th, 2010 at 11:22:11 AM EST
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To clarify, rating agencies are supposed to provide independent analysis of risk in order to solve the problem of people misrepresenting to others what their own data mean by creating a common means of comparison. They are supposed to prevent people from lying in the interpretation of data, not prevent people from actually lying about the data themselves.  Stopping people from cooking the books is what auditors and other regulators do. But cooking the books is not what is given as the cause of the Great Recession -- bad and biased interpretation of the real risks of failure are.  It's the risk ratings that failed, not the auditors.
by santiago on Tue Apr 27th, 2010 at 11:44:02 AM EST
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No, usually it's just too expensive to pull large data sets like that, so you only do it if you know the person who requested it has the capability of making sense of it.  Few do, since it requires a lot of IT as and finance skills and specialized equipment to analyze large financial data sets. The risk is that someone will look at it and come to the wrong conclusions because they don't know what the data mean.  That said, however, the better purveyors of things like mortgage backed securities, such as GMAC,  did provide useful, detailed data for public inspection accessible by website on each security.  It may have made their securities more valuable in the marketplace, but those securities went bust just like everyone else's, so it wasn't lack of underlying data that kept rating agencies in the dark -- they were selling these things as "sub" prime and "alternate" prime securities after all -- completely open about the fact that these things were backed by junk.  The AAA ratings came from the way bond tranches were organized and insured so that even if things went bad, some investors would still get paid before others (and mostly still are) so that their risk was minimal.  More underlying data about the loans could have added nothing to a rating agencies' judgment, since the rating has almost nothing to do with underlying data about individual loans.
by santiago on Tue Apr 27th, 2010 at 10:26:13 AM EST
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If you're unable to conduct an independent risk assessment because the piece of paper is too complicated, then you do not buy the piece of paper.

If you're an institutional investor then you should have that capability, unless the security in question is excessively complicated (in which case you don't want to buy it). If you're not an institutional investor, then you shouldn't be playing in the capital markets with money you can't afford to lose.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 10:32:02 AM EST
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Rating agencies like S&P don't buy anything and their ratings have almost nothing to do with checking underlying data on securities.  They just set the odds based on reported information.  Institutional investors, on the other hand, should have the capability of analyzing the data before they buy anything, and most did.  But it still didn't save them from getting burned because lack of data wasn't the problem.  It was their beliefs and models about how the world worked that were wrong.
by santiago on Tue Apr 27th, 2010 at 10:43:57 AM EST
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Institutional investors, on the other hand, should have the capability of analyzing the data before they buy anything, and most did.

Did have the capability, or did use the capability?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 27th, 2010 at 01:13:56 PM EST
[ Parent ]
You can drag a horse to water ...
by santiago on Tue Apr 27th, 2010 at 03:41:45 PM EST
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