Calculated Risk has a post this morning that really caught my eye and from which I derived the graphic above. You can click on the image for a larger version.
I’ve introduced a couple of trend lines. The first, in black, marks the trend for each bond classification from the beginning of the period in question to date and the second, in gray, marks the trend for each bond classification from the beginning of the period in question to the beginning of a serious deviation from trend and extends that to date.
First, look at the beginning of the obvious spike in yields. I measure that as Lehman Brothers filing for bankruptcy. Clearly, in hindsight although any number of people said so at the time, the Bush Administration made a serious error in its handling of the situation with Lehman Brothers. That spike isn’t just lines on a page. It’s a snapshot of a panic in the financial services sector. When you recognize that the spike indicates a sharp increase in the cost of borrowing for companies it also measures who knows how many thousands of jobs lost and who knows how many corporate bankruptcies that probably could have been avoided or, at the very least, slowed.
Over time the panic has subsided and we’ve largely returned to the trend.
But not entirely. Look at the difference between the spreads of the two bond classifications as they’ve actually materialized and as they would have been had they returned more or less completely to the prior trend.
Finally, note that much of the difference in the spread comes from Baa bonds paying a substantially higher yield.
All of these things suggest to me that, while the panic may be over, the graph above paints a portrait of a financial that is still ongoing.
I’d be remiss if I didn’t mention another alternative. It may be that the rating institutions are cooking the books and, as has been suggested, we shouldn’t pay any attention whatever to what they have to say.
However, after mulling over that op-ed a bit I’ve begun to wonder about it. When a guy who ran a bond rating agency tells you not to pay any attention to bond rating agencies, you’ve got to take pause.
I can’t help but wonder if he’s realized that the bond rating agencies have their own responsibilities for the problems that are ongoing. Is he doing damage control?
If bond rating agencies are selling snake oil, the solution isn’t to ignore them any more than the solution to dangerous and ineffective patent medicines wasn’t not to buy them (although that would certainly have solved the problem). The solution is to ensure that the rating agencies are doing their job. That’s something we might consider when we begin imposing new regulations on the financial sector.
Alternatively, we might insist they put up a bond of some sort to indemnify against the losses caused by wildly inaccurate ratings. And that brings us around to AIG. Who insures the insurers?