Wednesday, June 17, 2009

Ratings want to be free

Embedded video is unfortunately not a very efficient way for me to absorb information, particularly when this video does not show up in my RSS feeds. But I not only clicked through, but watched the whole damn thing when Barry Ritholz' Big Picture pointed me to a video of two gentlemen proposing an alternative to the big ratings agencies.

The two gentlemen - computer scientists Jesper Andersen and Toby Segaran - have formed an open-source venture called Freerisk, which describes itself as "project with the goal of making freely available the data, algorithms and tools necessary to perform risk modeling". More bluntly, the founders, as you can see from the above-linked video, want to loosen the stranglehold of the agencies on credit analysis.

This is a timely, worthy, necessary and maybe even feasible goal. The founders acknowledge that access to the data necessary for debt analysis needs to be improved, and that this data should be provided, presumably to the SEC in a machine-readable format. The algorithms necessary to perform this analysis would be open source.

I say timely because the Obama administration's instincts have been to ask issuers and agencies to provide a greater amount of information, and I say worthy because, as the Freerisk founders demonstrate persuasively, investors need to have access to better means of measuring credit risk. The current system of semi-regulated, issuer-paid, nationally-recognised statistical rating organisations is simply not stable.

I say maybe feasible, because if you're going to start trying to chip away at the agencies' dominance, you'll start, much as newer outfits like Gimme Credit and Egan-Jones have, by looking at corporate debt. The models are simpler, and the inputs and assumptions are much more transparent.

But let me look now at some of the potential pitfalls. I have no idea, for starters, whether publicly-registered bond issuers provide the right information in a homogenous fashion, in the same way that registered equity issuers do. Issuers of bonds that can only be bought by accredited large investors (Rule 144A buyers) do not have to disclose any information at all. You might say that 144A buyers are presumably less in need of this sort of protection, but then you wouldn't have been reading the papers much recently.

Then there's the fact that agencies have not had a particularly horrible time with their corporate ratings of late. Now this is all relative, and their work on financial institutions has been, at the very least, far from timely, but the agencies' biggest failure has been in the rating of structured products.

The Freerisk principals say quite clearly that having proprietary and closed algorithms was one of the factors that got us into this mess in the first place, but if Egan-Jones can't work out a way to break into the rating of structured products, you can assume that the barriers to entry in that business are fairly high. It could be that it's easier than the big boys make it out to be, but he way the industry developed suggests not. Which is not, of course, to say, that issuers can or should be concentrating on structuring fiendishly complicated instruments these days.

They do do things differently in debt markets, this peculiar mixture of wild west and gentleman's club. In equity markets the assumption is that any idiot should be allowed to go out and own any stock they like. In debt markets there's an assumption that some products are definitely left to the professionals. which doesn't make a massive amount of sense because debt products - in general - provide a much more stable income stream and better recovery prospects, though they also require a bit more supervision of issuers, whether directly or by a trustee.

Regulators have traditionally enforced this distinction by leaving the decisions to the agencies, and there's no sign that they will either let investors buy whatever debt securities they feel like or staff up in a sufficient fashion to make these distinctions themselves. That decisions still confronts them.

But chipping away at the edifice of ratings agency dominance will be a gradual process (I see challenges to their use of First Amendment protections to be another means of doing so). I see Freerisk being complimentary to efforts by competing agencies to check their rivals' work by offering unsolicited ratings. Regulators have traditionally frowned on unsolicited ratings, seeing them as a form of blackmail (hire us or we'll put out an unsolicited rating that makes you look bad). But they're probably the quickest way to establish a means of checking ratings shopping among the big agencies.

It would also get investors used to the idea that even if a competitor, whether paid for or free, doesn't have the best analytical tools, then if it has a better record with the way its using assumptions and inputs it could still provide an alternative to the big agencies. I'll be curious how it works out.

Friday, June 05, 2009

Hanger Wan

About the only thing that can rouse me from my blog torpor these days, aside from Doom Metal, is the latest series of exciting gyrations at the Atlantic Yards project.

I happened to be out of the country acting as a heritage management professional when Senator Perkins called a massive public meeting about the project but neglected to stock it with any useful questions or event security. The result was a meeting that by all accounts managed to be both rowdy and substance-free, not unlike the empty theater that is the city's rent-review process.

I'm still unsure about the provenance of the people who were so insecure about the Atlantic Yards rationale that they needed to drown out a rather milque-toast set of interrogations. I read variously that they were genuine unionised construction workers or a mob assembled by the community groups that Ratner has paid to support the project. That said, I have an enduring fascination with the iconography of the American hard-hat. That the use of the hard-hat in the practice of wedge politics still has an edge even as America's native working class has largely abandoned the construction sector to recent, usually non-union, immigrants, and the country's heavy industry sector has hollowed out.

I thought about this as I read Rick Perlstein's wonderful Nixonland, and his account of the occasion when the city's construction workers acquired a taste for hippy blood. Perlstein's book has been much praised by bloggers, usually as way of explaining the yawning cultural chasm that exists in American politics. I liked it because my entire knowledge of the politics of 60s and 70s America comes from Hunter S. Thompson books, and I know, deep down, that that isn't healthy.

Some of the most fascinating bits of the book are those that illuminate just how culturally divided New York City was. I'm referring, of course, to a period before the flight to the suburbs, a time when the city was host to a huge white working class population. Sorry, I should have said, huge violent white working class population.

I'm thinking about the photo from 8 May 1969 of the stockbroker and hardhat apparently joining forces to beat up a student protester. You can see it here. I'm not going to be crass enough to compare arguments over an undistinguished basketball arena with the Vietnam War, but it's a nice and visceral illustration of the marriage of labour and capital in action.

The hard-hats kicked off the beating, and the white-collar worker joins right in. It illustrates the coalition that Nixon assembled to power his two presidential victories despite being massively weird, old and dishonest. So why does this tactic still endure in the Brooklyn of 2009? I mean, this is Old Skool.

It's possibly not that weird though, since Bruce Ratner learned his lessons about urban development as director of a Model Cities program for the Lindsay administration, which was the hapless bystander to the unrest of the late sixties in the city. He presumably learned the value of keeping labour onside, as well as, presumably, the value of dubious, though deniable, racial rhetoric in undermining opposition.

I doubt, though, that portraying construction workers as the stooges of capital would have any more force now than it did in 1969. It would probably be even less effective than following the marshmallow-brained Marty Markowitz about while dressed as a gigantic phone and screaming "MARTY! IT'S BROOOOOOCE" every time he tried to get on television (it's a reference to a moment in a New Yorker article when he had a very obsequious phone call with Ratner. Oh, never mind.)

I was tempted to carve out the news about the replacement of Frank Gehry with the hanger-building hacks into its own post, but the pub beckons, and I don't have much to say about architecture.

I'll just leave you with this datapoint. Last year, the Louisville Arena Authority started construction on a $238 million arena with a capacity of 22,000 seats. That can host ice shows, concerts and swimming. Even after tossing Frank Gehry's design and "value engineering" the hell out of the arena, they've managed to come up with an $800 million arena that won't host ice hockey and has a capacity of 18,000. AND IS UGLY AS HELL.

I'm not going to go over the model again. I'm not even going to argue about whether New Yorkers are going to pour three times as much love into a second-rate NBA basketball franchise as the good people of Louisville will into their top-ranked NCAA basketball franchise.

Let's remember the lower naming rights payments from Barclays, the slowing economy, the lackluster suite sales, the crumbling political support and say: Good. Luck. With. Your. $800 million. Hanger. Brooce.

[Addition: It occurred to me, several days after completing the post, hitting the pub, and trolling for link love, that there's an excellent way to tie the two halves of this post together. There reason why Ratner is saddled with an $800 million hanger, despite plumping for the most functional design he could get away with, is the cost of his unionised construction workforce. Those same guys who wrecked the Perkins hearing. That, my friends, is karma.]