A symbiote’s life is not a happy one: Part 1, blaming the raters
“Symbiosis — threat or menace?”
That, at any rate, is the accusatory damned-if-you-don’t thesis presented by the Wall Street Journal in a lengthy and intriguing, albeit insufficiently interpreted article on the subprime mess and the contributory, one might even say enabling, role plated by the trio of rating agencies:
I know whom I’m going to blame!
– S&P, Moody’s, and Fitch, announced by the Journal’s Burma-Shave-sign multi-line header:
How Rating Firms’ Calls
Fueled Subprime Mess
Benign View of Loans
Helped Create Bonds
Led to More Lending
[Doesn't that read like a badly translated tanka?]
In the far center/
Nearer,
Capital markets crashing/
In the long run, we go bust/
As the subprime mess unfolds around us — right now we’re in a liquidity crunch brought on by temporary panic among credit analysts used to smooth continuous price changes, not sudden air pockets — what can we learn from the symbiotic relationship of rating agencies and issuers?
Of greater importance, what happens now to the agencies? Does the rating system itself need fundamental change? This multi-part post tackles those key questions, which are among the right public policy questions to be asking.
[In the coming weeks, I'll be posting a lot about subprime loans and the capital markets, although the pieces will tend to be long and analytical. For breaking news, I can't compete with the financial press, who are doing a fine job of chronicling the latest surprises … but I'll seek to out-analyze and out-explain them.]
Don’t expect this kind of analytical capacity in Rupert Murdoch’s Journal!
Since the term will be thrown around as if it’s intrinsically derogatory, let’s start with the basics. The Wikipedia definition is a good one:
The term symbiosis (Greek for living together) can be used to describe various degrees of close relationship between organisms of different species.
Sometimes it is used only for cases where both organisms benefit, sometimes it is used more generally to describe all varieties of relatively tight relationships, i.e. even parasitism, but not predation.
Most people connote symbiosis as mutual benefit: you scratch my back, I’ll scratch yours
You pick off my body lice, I’ll pick off yours
In nature, symbiosis is the natural outcome of specialization, and is most common when two organisms have vastly different scale, size, or mobility:
In either case symbiosis is much more common in the living world and much more important than is generally assumed. Almost every organism has many internal parasites. A large percentage of herbivores have mutualistic gut fauna that help them digest plant matter, which is more difficult to digest than animal prey. Coral reefs are the result of mutualisms between coral organisms and various types of algae that live inside them. Most land plants and thus, one might say, the very existence of land ecosystems rely on mutualisms between the plants which fix carbon from the air, and Mycorrhyzal fungi which help in extracting minerals from the ground. In fact the evolution of all eukaryotes (plants, animals, fungi, protists) is believed to have resulted from a symbiosis between various sorts of bacteria: endosymbiotic theory.
Symbiosis, in short, adds value — why fight when you can trade services? A classic example of mutual benefit between the clownfish and the anemone:
An example of mutual symbiosis is the relationship between clownfish of the genus Amphiprion (family, Pomacentridae) that dwell among the tentacles of tropical sea anemones. The territorial fish protects the anemone from anemone-eating fish, and in turn the stinging tentacles of the anemone protect the clownfish from its predators (a special mucus on the clownfish protects it from the stinging tentacles).
Clownfish and anemone are an example of mutual freedom of action (the animal having more than the plant), but there are biological examples of the host completely encasing the symbiote, as in coral:
Although corals can catch plankton using stinging cells on their tentacles, these animals obtain most of their nutrients from symbiotic unicellular algae called zooxanthellae.
Isn’t nature wonderful?!?
In financial markets, symbiosis arises when one company’s outputs are another company’s inputs (or a small company joining with a larger one that has complementary skills, scale, and resources).
I’ve delved at such length into the background of symbiosis because the journalists’ working hypothesis is that all business symbiosis is bad [As opposed to the symbiosis between journalists and disgruntled anonymous leakers, which is good? -- Ed. Hey, they're journalists, they didn't major in consistency. -- Auth.] whereas in reality, much symbiosis is good, but like so many other things good in moderation, too much is — well, too much.
Such as the tendency for the symbiote resident inside a larger host to empathize with the host, identify with the host, and root for the host.
In 2000, Standard & Poor’s made a decision about an arcane corner of the mortgage market. It said a type of mortgage that involves a “piggyback,” where borrowers simultaneously take out a second loan for the down payment, was no more likely to default than a standard mortgage.
My sportswriting idol Bill Simmons has long preached the value of a “Vice President of Common Sense“:
Vice-President-for-Life-of-Common-Sense
I’m becoming more and more convinced that every professional sports team needs to hire a Vice President of Common Sense, someone who cracks the inner circle of the decision-making process along with the GM, assistant GM, head scout, head coach, owner and whomever else. One catch: the VP of CS doesn’t attend meetings, scout prospects, watch any film or listen to any inside information or opinions; he lives the life of a common fan. They just bring him in when they’re ready to make a big decision, lay everything out and wait for his unbiased reaction.
S&P evidently needed a Vice President of Common Sense.
There is no way on God’s green earth, as my mother would say, that piggybacking the down payment could possibly be as safe as straight down-payment.
While its pronouncement went unnoticed outside the mortgage world, piggybacks soon were part of a movement that transformed
Nothing to worry about here; safe as someone walking by himself
Six years later, S&P reversed its view of loans with piggybacks. It said they actually were far more likely to default.
I shoulda known
By then, however, they and other newfangled loans were key parts of a massive $1.1 trillion subprime-mortgage market.
We’re hedging our bets with these newfangled gadgets
Hey, kids, can you say, ‘detrimental reliance’? Can you say ’standard of due care‘? Can you spell L-I-T-I-G-A …?
Today that market is a mess. As defaults have increased, investors who bought bonds and other securities based on the mortgages have found their securities losing value, or in some cases difficult to value at all.
Only recently have the news stories recognized the difference between a value crunch (things are objectively worth less than they were before) and a liquidity freeze (where it doesn’t matter what things are worth because nobody wants to lend).
Sorry, boys, you can’t redeem your Collateralized Debt Obligations right now …
Just as the Depression was triggered in part by a run on the banks, the last weeks have seen the twenty-first century equivalent: a sphincter contraction not seen in nearly twenty years, as all of a sudden nobody wanted to lend anybody money for anything.
Some hedge funds that feasted on the securities imploded, and investors as far away as
It was lenders that made the lenient loans, it was home buyers who sought out easy mortgages, and it was Wall Street underwriters that turned them into securities.
Even a dummy knows that!
Anyone familiar with the journalistic style knows the next word coming in this story:
But credit-rating firms also played a role in the subprime-mortgage boom that is now troubling financial markets.
[Continued tomorrow in Part 2.]
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