Michael Lewis, in his highly entertaining new book, The Big Short, has a pop at ratings agencies (amongst a bazillion other targets). All the big Wall Street firms, he writes, were highly effective at manipulating Moody’s and Standard and Poor’s:
Everyone on Wall Street knew that the people who ran the models were ripe for exploitation. ‘Guys who can’t get a job on Wall Street get a job at Moody’s,’ as one Goldman Sachs trader-turned-hedge fund manager put it.
Inside the rating agency there was another hierarchy, even less flattering to the subprime mortgage bond raters. ‘At the rating agencies the corporate credit people at the least bad,’ says a quant who engineered mortgage bonds for Morgan Stanley. “Next are the prime mortgage people. Then you have the asset-backed people [dealing with sub-prime mortgages, for the most part], who are basically like brain dead.
Wall Street bond trading desks, staffed by people making seven figures a year, set out to coax from the brain-dead guys making high five figures the highest possible rating for the worst possible loans. They performed the task with Ivy League thoroughness and efficiency.
Despite their pivotal and disastrous role in the financial crisis, business for the ratings agencies is booming. If anything, their influence, meanwhile, has grown, especially over governments, as they threaten countries with a sovereign debt downgrade.
I was especially intrigued by media coverage for a recent report from Moody’s, which claimed that the US, UK, Germany, France and Spain are all at risk of social unrest as governments struggle to get their finances under control. According to Moody’s Chief International Economic and Financial Policy Analyst, Pierre Cailleteau:
Growth alone will not resolve an increasingly complicated debt equation. Preserving debt affordability at levels consistent with AAA ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion.
We are not talking about revolution, but the severity of the crisis will force governments to make painful choices that expose weaknesses in society.
Strong stuff. And interesting too. One of the key questions for the next few years is whether the fallout from the financial crisis will be toxic enough to damage, or even break, some societies.
So I thought I’d read Mr Cailleteau’s report, rather than just relying on the Telegraph’s summary. I wondered how strong his analysis was. Was he a smart guy or one of those dubbed in Lewis’s book as the ‘brain dead’?
But then I hit the buffers. Go to Moody’s website and there’s no content at all available unless you register (which includes pretending to read a 6103 word user agreement – the site knows if you haven’t at least scrolled through it).
Once I’d gone through all this rigmarole and logged in, I was told that access to Cailleteau’s report “is not part of your current service”. (I was allowed to read the report’s press release. Big deal. I struggle to think of another organisation that requires registration for that.) Nor could I find a biography for Cailleteau. Only one of his reports was freely available to subscribers (a research note on methodologies). And even the link to pricing information for his ‘social unrest’ report was not working.
So I am left none the wiser about Cailleteau’s argument or credentials. All I do know is that he dismissed talk of a systemic global banking crisis in August 2007, a year before [corrected] Lehman’s nearly brought down the world’s economy.
Of course, anyone can make a mistake (though that one’s a doozy) – but surely it is no longer acceptable for the ratings agencies to hype their work to the press and lord it over the world’s economies, without letting us see the evidence on which they base their diagnosis and prescriptions.
More transparency please. Either on a voluntary basis. Or enforced through regulation.
As oil continues its crazy gyrations (yesterday’s price – $48), news is proliferating that investment in new exploration and production is falling off a cliff. Monday’s NYT, for example, had this:
From the plains of North Dakota to the deep waters of Brazil, dozens of major oil and gas projects have been suspended or canceled in recent weeks as companies scramble to adjust to the collapse in energy markets.
Oil markets have had their sharpest-ever spikes and their steepest drops this year, all within a few months. Now, with a global recession at hand and oil consumption falling, the market’s extreme volatility is making it harder for energy executives to plan ahead. As a result, exploration spending, which had risen to a record this year, is being slashed.
The precipitous drop in oil prices since the summer, coming on the heels of a dizzying seven-year rise, was a reminder that the oil business, like those of most commodities, is cyclical. When demand drops and prices fall, companies curb their investments, leading to lower supplies. When demand recovers, prices rise again and companies start to invest in new production, starting another cycle.
Now for Dan Drezner, all this poses a question:
So, let me see if I have this right:
If oil prices are sky-high, the energy sector explains that it will be slow to develop new fields, because exploration requires massive fixed investments and no one knows what the price of energy will be 5-10 years from now;
If oil prices are low, the energy sector explains that it is unprofitable to develop new fields because… energy prices are low.
Well, actually that is more or less the long and the short of it; as I argued back in July, the oil price is set to continue its recent yo-yoing for as long as we continue without a clear ‘signal from the future’ about the long term demand outlook for oil. After all, if you were an investor considering ploughing money into oil fields that were only profitable above $60 or $70 a barrel, and which would take many years to recoup the capital cost, wouldn’t you apply a pretty big risk premium if you saw prices collapsing to below $50 from a high of $147 less than six months earlier, with the potential in the background for future climate policy to cause demand to plummet?
Problem is, though, that without that new investment, we’re on track for a serious price crunch at some stage, as both the IEA and Chatham House have argued. So how to square the circle? Well, Nick Butler – who was John Browne’s chief of staff at BP and now heads the chairman of the Centre for Energy Studies at Cambridge’s Judge Business School -has a proposal in the FT yesterday. He writes:
If the energy ministers want to stabilise the market they should begin by commissioning a detailed, independent analysis of what went wrong. They should then develop the stabilising mechanisms that would limit the possibility of any repetition of 2008.
The most effective mechanism would be agreement on a broad target range for prices – say, between $50 and $75 a barrel – backed by a strategic stock holding to be augmented or deployed when prices diverged from the range. To support such an agreement trading would be limited to those with a direct physical interest in the market.
From a new base of relative stability ministers could consider the longer-term issues that will shape the energy market: the huge need for infrastructure investment ($350bn a year according to the International Energy Agency) and climate change.
This idea of a price band is clearly starting to gain ground in the energy think tank world – I heard a very similar idea mooted by an attendee at a Shell / Economist energy breakfast in London last month. But I’m not so sure. While Nick Butler’s clearly right to refer to the need to integrate energy security with climate change, why not go one step further – and use a comprehensive climate framework to provide the long term oil price stability that’s needed to bring the right amount of new investment on stream?
Think about it. Imagine a climate regime in which the emission targets are sufficiently long term (i.e. multi-decade rather than in 5-yearly increments as under Kyoto), and which is based on a quantified stabilisation target, which therefore means that all major emitters have binding caps. (You can argue about political feasibility in the current political climate, but the fact remains that a global deal on climate that actually solves the problem will have to satisfy these conditions anyway – and sooner rather than later if we’re to limit warming to two degrees C.)
What such a regime would also achieve, with no extra work needed, is to provide long term predictability on how much fossil fuel will be being consumed – for decades ahead. True, it wouldn’t tell you exactly which fossil fuels – coal versus oil, for instance – but since they’re used in different markets (oil mainly for transport, coal and gas mainly for power generation and heat), you could make a pretty good guess.
And now imagine again that you’re the potential energy investor we met earlier. All of a sudden, you can invest with much more confidence – and what’s more, knowing the level of demand will enable you to watch what other investors are doing too, so that more or less the right amount of new oil is brought on stream to meet projected demand, within the context of a global deal for climate.
Oh, and there’s one other advantage: given that a global deal on emissions is primarily an agreement between energy consumers, you can worry just a little bit less about OPEC’s congenital inability to stop itself from cheating…
Update: meanwhile, “OPEC oil ministers meet on Wednesday to remove a record 2 million barrels per day from oil markets as they race to balance supply with the world’s collapsing demand for fuel … Saudi Arabia, the world’s biggest oil exporter, has led by example — reducing supplies to customers even before a cut has been agreed to help push prices back toward the $75 level Saudi King Abdullah has identified as “fair.””