The Magazine


Nov 27, 1995, Vol. 1, No. 11 • By JAMES HIGGINS
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A recent and notable example: Japanese banks. By 1990 virtually every bond trader, salesman, and portfolio manager in the United States understood that the Japanese banking system was a house of cards; that purportedly ample capital ratios were built on ludicrously inflated asset values. All the market participants had gotten the joke, but the rating agencies hadn't. They were focused on nominal compliance with Bank for International Settlements capital ratios and other statistics that turned out to be irrelevant; so they were still giving triple-A ratings to a number of Japanese banks. The rating agencies apparently had not a care or a clue about the business practices that were leading these banks to hold at least $ 370 billion of bad loans.

I particularly remember trying at that time, as a mortgage trader, to sell one bond that was rated triple-A by virtue of a supporting letter of credit issued by the U.S. branch of a prominent Japanese bank. My colleagues and I knew from the outset that the deal would be a tough sell because of the undesirable letter of credit. One sales call was to a prominent west coast money manager. "In what trailer," came the money manager's withering reply, " is that branch located?" Other money managers were less caustic but equally -- and correctly -- dismissive of the triple-A rating. So it's not particularly surprising that a rating agency that didn't understand what was financially wrong with Japanese banks wouldn't understand what's financially right about a serious effort to balance the federal budget.

Finally, one must note the similarity between Standard & Poor's pronouncement and Treasury Secretary Rubin's rhetoric. Even the New York Times observed that Standard & Poor's warning "almost exactly parallels warnings issued recently by Mr. Rubin." Secretary Rubin wasted no time showing up on the network talk shows, waving Standard & Poor's "objective" caution.

Coincidence? Perhaps, but perhaps not. Mr. Rubin's former firm, Goldman Sachs, must deal with rating agencies every day. Perhaps Secretary Rubin's direct and indirect contacts at Standard & Poor's haven't all disappeared. The secretary should be called before Congress and asked under oath whether he took any steps, direct or indirect, to encourage Standard & Poor's to issue this warning. Telephone records should be subpoenaed if necessary. If it is established that Secretary Rubin did encourage Standard & Poor's statement, he should pay the same penalty that any other chief financial officer would pay if found encouraging a negative rating-agency report on his employer: He should be fired.

James Higgins has worked for eight years for primary dealers in U.S. government securities, most of that time trading securities rated by the major rating agencies.