There’s No Such Thing as an Objective Credit Rating

Vickie Tillman of S&P has an

interesting letter in the WSJ today, defending the ratings agency against

the kind of charges made

by Jesse Eisinger in last month’s Portfolio. S&P is not conflicted,

she says, by the fact that its income comes from the very entities that it is

purportedly policing:

Issuers structure deals, and we rate these deals based on our criteria —

criteria that are publicly available, non-negotiable and consistently applied…


credit ratings provide objective, impartial opinions on the credit quality

of bonds.

The word that jumps out at me here is "objective". And that word,

in this context, means something only insofar as it is being contrasted with

its opposite, "subjective". A subjective rating, on this view, would

be a bad thing, while an objective rating is a good thing.

Now what would the difference between a subjective credit rating and an objective

credit rating? A hint is given by the first sentence that I quoted. A subjective

credit rating would be one individual’s, or one company’s, point of view. It

would be informed by that individual’s, or that company’s, expertise, but ultimately

de gustibus non est disputandum, and all that.

On objective credit rating, on the other hand, would be something much more

rule-based: it would have as its foundation "criteria that are publicly

available, non-negotiable and consistently applied". You take the financials

of any given issuer, you drop those financials into a black box, and out the

other end pops an entirely predictable and certain credit rating; the person

doing the dropping has nothing to do with it, and might as well be a trained

monkey for all the difference they make.

Now here’s the thing: if credit ratings really were objective, then there wouldn’t

be any need for ratings agencies in the first place, and you wouldn’t have different

ratings agencies competing against each other, and you certainly wouldn’t have

ratings agencies making enormous sums of money. After all, anybody could simply

use the ratings agencies’ publicly-available, non-negotiable and consistently-applied

criteria to generate the exact same ratings that S&P, Moody’s, and Fitch

charge lots of money to provide.

Now in the real world, people who work at credit rating agencies tend to be

well paid and highly-qualified individuals. Quite often, they are poached by

investment banks, either for their knowledge of how the sausage is made or else

just because they’re very bright individuals with a lot of insight into the

credit markets. I’m sure that Vickie Tillman would agree that she and her colleagues

are able and valuable professionals, and that S&P is one of those companies

where the real value walks out the door every evening.

But she can’t have it both ways. Either S&P hires smart people to make

subjective decisions, or else it basically hires anybody who can follow simple

rules which spit out a rating according to predetermined criteria. (Although

even then, it would need at least a few people to subjectively be in charge

of changing and updating those criteria over time.)

In reality, of course, ratings are subjective, not objective. But it’s interesting

that Tillman seems so keen that we think otherwise.

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