ES: Well, look: I never wanted that. Remember, way, way back, we tried to come up with all the different permutations that were out there. We wanted to have independent research. And who’s gonna pay for it? There was a notion—and this caused a hullabaloo when it was floated; it wasn’t even my idea, but conceptually there’s nothing wrong with it—that the stock exchange would have research. The stock exchange as a not-for-profit would say: “Look, you guys go out there and do research” sort of as an academic exercise. But the question is, in this day and age, how can you derive a revenue stream from research whether you’re an analyst in the tech sector of a Morgan Stanley or you’re Fitch doing bond analysis. Because the information? Once it’s out there you can’t protect it very well. And if you put a negative rating, who’s going to pay for it? These are real problems. But what we do know is that as a consequence of this, the bond ratings—much like the analysts that we pursued—were uniformly and excessively positive.
NYO: The consequences of these excessively positive ratings have greater implications on the world beyond the private sector. You’ve said that “only government can take the steps necessary to overcome market failures.”
ES: Well, one type of intervention might just be: Take away all the government imprimatur that the rating agencies have and say ‘These guys are no better than what you have made of them in the past. They really haven’t spotted anything important. And you’ve got to do your own work.”
NYO: What was your reaction when you saw the S&P downgrade of American debt?
ES: I thought it was…interesting. It wasn’t an economic analysis.
NYO: It was a political analysis.
ES: It was a political analysis. The one thing we’ve thought there might be some modicum of skills retained by these companies was economic analysis. We haven’t ever viewed them as being political barometers. So now, in a way, they’re putting on an entirely different hat saying as a political matter, they’re downgrading our debt.
NYO: Are they out of their depth?
ES: I don’t think they are. But I don’t think they have any unique skills either. They’re smart people, and I think they reached the same conclusion that many folks have reached: our government has been somewhat—or greatly—dysfunctional dealing with macroeconomic issues, and that we’re kicking the can down the road both in terms of the deficit and in terms of what I view as the more important issue, job creation. But we don’t need S&P to tell us that. In other words: this wasn’t a very sophisticated analysis of debt exposure, where they picked up something we hadn’t seen about some pension obligation, and said “A-ha! Now we see where you’re hiding it. Hence: we’re downgrading you.”
NYO: What’s interesting about it, though, is that they actually did go out on a limb and distinguish themselves from the other agencies. And it feels like they’re being punished for it.
ES: They were not wrong in their political analysis. They’re wrong in their economic analysis. The risk of a default, having watched this exercise, is actually lower than it was in the past. In a sense, you could say that even with the Tea Party there, at the end of the day everybody said “We will not tolerate a default.” We know that. At that point I don’t think the downgrade makes sense, when you look at where we now stand in comparison to other government and private sector entities. Having said that, there was some criticism that this was sort of a finger back in the eye of government saying “Okay, you want to give us a tough time for missing the sub-prime debt? We’ll show you we still have some cards to play.” You know, look: I don’t want to challenge motive. Frankly, the market, to a great extent, has ignored their downgrade.
NYO: Funny how that nebulous “market” will take the ratings agencies’ stamps of approval when it wants them, but ignore them otherwise. Are they just totally useless right now?
ES: The rating agencies have provided a legal and emotional backstop for entities that have to make certain decisions and need to rely upon something. It’s somewhat akin to opinion letters in a takeover context. You need something that gives you the legal foundation to act. So if you’re a board of directors or an investment committee you can say “here’s our portfolio, and we’ve done our due diligence. Here are the rating agency’s statements.” You don’t really think that they’re worth that much. On the other hand, you also know that you don’t have the internal capacity to analyse the bonds out of some tiny sewer department that’s issuing the debt in the tiny county in some state out in the Midwest. To that extent, they provide some sort of baseline utility.
NYO: Allow us a moment of total, wide-eyed naivety: As someone who’s navigated the ridiculous thoroughfare of government bureaucracy, what are the odds that any legislator anywhere would take significant action on the systemic issue of ratings agencies?
ES: Probably slim.
NYO: Why? Because it seems like something that…
ES: Should have been done a long time ago? Or any prosecutor for that matter. I mean, there hasn’t been any meaningful effort to take a hard look at it.