In print: The new austerity, and the trouble with Moody’s and S&P

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I have two pieces in the new issue of Time with a “10 ideas that are changing the world” on the cover. One of them is one of those 10 ideas, really less an idea than an incipient trend, which I called “The New Austerity.” It begins:

Journalists and others with a tendency to see glasses as half empty have a long history of pronouncing the American consumer maxed out. “Time for a New Frugality,” this magazine declared in 1973. “Over the Ears in Debt,” it chimed in again in 1987. It wasn’t just TIME. Historian of credit Lendol Calder has assembled a long list of worried headlines through the decades: “Debt Threatens Democracy” (Harper’s, 1940), “Is the Country Swamped with Debt?” (Business Week, 1949), “Never Have So Many Owed So Much” (U.S. News & World Report, 1959). And so on.

Amid all this hand-wringing, Americans have kept piling on more and more debt. The last significant episode of belt-tightening came during the recession of the early 1980s. But that turned out to be just the prelude to a quarter-century of growing profligacy, capped by a final half-decade of mostly mortgage-related fun that will go down as one of the most reckless borrowing-and-lending binges ever.

Now that particular binge has come to a crashing end, and the credit worriers believe their moment may have finally arrived. “I’m not saying we’re going back to our parents’ level of frugality,” says David Rosenberg, North American economist at Merrill Lynch. “But what we have witnessed in the past 20 to 30 years — and especially the parabolic credit growth of the last five years — is going to be bursting in the next decade.” Read more.

The Lendol Calder list is from page 293 of his book Financing the American Dream: A Cultural History of Consumer Credit. And yeah, I’ve been hammering on this argument for a while.

I’ve also got my regular column in the issue. It begins:

The people at Moody’s and Standard & Poor’s are used to catching flak when debt markets blow up. Why didn’t they see the bankruptcy of California’s Orange County coming in 1994? Why did they fail to account for the currency risks brewing in Thailand and Indonesia and South Korea in 1997? And how was it that they were still rating Enron’s debt as investment grade four days before the company went belly-up in 2001?

The furor over such missteps usually fades quickly. After a congressional hearing or two, the ratings agencies have always been allowed to go their merry and profitable way. And why not? Inability to see into the future isn’t a crime, plus there has usually been someone else available to take the fall–like Arthur Andersen in the Enron case.

This time around, though, the ratings agencies didn’t just fail to see a financial calamity coming. They helped cause it. Why did collateralized debt obligations (CDOs) based partly on risky subprime mortgages lead to so much trouble? Because Moody’s and S&P awarded them dubiously generous letter grades. It’s the same story for the mostly incomprehensible tizzy over bond insurance.

What can we do about this? There’s actually a simple answer: just declare our independence from bond ratings. Read more.

This stop-relying-so-much-on-ratings argument seems to have originated with a 1999 law journal article by University of San Diego law professor Frank Partnoy, whom I quote elsewhere in the column. Finance professors Charles Calomiris of Columbia and Joseph Mason of Drexel reprised it in an FT op-ed piece last summer. And as I noted yesterday, the President’s Working Group on Financial Markets raised the idea, albeit in the most timid fashion possible, in its new report on how to fix financial markets.

Readers of the print version of the column may notice a really stupid error: I say Moody’s made $702 billion in profit last year. That’s supposed to be million. Oops. I checked all the numbers in the column three or four times, but somehow my eyes just kept passing over that errant “b.” As did the eyes of the five or six other people who read the thing before it went into the magazine. It wasn’t until one of the editors of stumbled over it that we figured out there was an error. (As I write this, it still hasn’t been fixed in the online version either, but I think that’s coming any second now.)