Alex Preda, Framing Finance: The Boundaries of Markets and Modern Capitalism.

124  © C anadian  J ournal   of  S oCiology /C ahierS   CanadienS   de   SoCiologie  36(1) 2011
B ook  R eview /C ompte   Rendu

Alex Preda, Framing Finance: The Boundaries of Markets and Modern Capitalism.

Chicago and London: University of Chicago Press, 2009, 328pp. $US 25.00 paper (978-0-226-
67932-7), $US 65.00 hardcover (978-0-226-67931-0)



In the 18th century, Alex Preda observes, financial speculators were socially marginalized. They were thought to undermine government, to divert resources away from productive activity, and to weaken the moral order by severing consumption from work. These critiques live on, of course, but many of those who would previously have been described as speculators are now able to describe themselves as investors. Framing Finance shows how the distinction between speculation and investment developed in financial market actors’ favor during the 19th century, not least as a result of the increasing credibility, and then authority, of their own self-interpretations.

Preda sees the development of investors’ status as being inextricably linked to the development of the markets in which they operate. Yet he argues both that a description of changing collective beliefs or routines is insufficient to explain changes in markets made up of self-interested individuals, and that an individual-centred approach would fail to explain those markets’ coherence. Preda seeks to overcome this dilemma by exploring how coordination between individual market agents is achieved indirectly,  through  the  construction  of  boundaries  to  markets.  These boundaries are understood not only as distinguishing markets from the outside world, but also as establishing the ways in which markets can be observed from without. Preda therefore explores how the indirect forms of observation possible from outside the boundaries of markets influence both prevailing social perceptions of those markets and, relatedly, market activity itself. He finds that market participants have been active in shaping new channels of communication with those on the outside, and reviews examples ranging from the introduction of the stock ticker to the evolution of popular literatures about financial trading. Preda shows how these developments contributed to rendering financial markets an object of specialist knowledge, which in turn enabled the investors who attained that knowledge to accrue prestige.

Framing Finance draws on a rich variety of historical material, including the evolution of institutions and technologies, the diaries and publications of well-known traders, contemporary intellectual discourses, and fictional representations of investment and speculation. This material is fascinating in its own right, but it also reinforces Preda’s theoretical arguments: the description of one investor’s obsession with the stock ticker to the point of entering a “ticker trance,” for instance, evocatively reinforces Preda’s claims for the formative historical influence of such devices. As well as the history of the stock ticker, there is discussion of contemporary responses to some early stock market panics, and a description of the development of financial chartism (the use of past trends in stock prices to predict future ones). Throughout, Preda is interested in the development of financial knowledge, and in how investors have become able to present themselves as rational and even scientific actors. Yet despite investors’ considerable success in this regard, Preda also notes that the idea of speculators possessing a charismatic “vital force” irreducible to their knowledge has persisted from the 18th century up to the present day. This notion of a vital force is called into question by market actors during stock market panics, but only temporarily. Paradoxically, it is reinforced by the development of specialist financial knowledge, as those outside markets find themselves unable to demystify what happens within them.

Framing  Finance  adds  to  a  growing  body  of  work  that  explores how economic rationality is insufficient to explain the core institutions of economic life. Preda emphasizes the role of emotion, particularly in speculation. Yet this does not mean that he wants to give up on financial knowledge. On the contrary, he argues that overcoming the notion of a vital force embodied by special individuals in finance would require greater public education in financial matters, and asks whether such education should be seen as a public necessity, or even as a right, given the social significance of financial markets. Preda’s broader claims regarding the interrelationships between markets and society suggest that he would understand such education as being formative of markets themselves, as well as of the public’s understanding of them. It would therefore be interesting to see what kind of financial education he would design, and this could be a worthwhile direction for future work based on the suggestive conclusions presented here.

Viewed solely as economic history, Framing Finance might seem to contain more theory than it needs. Preda’s analysis of panics on the stock market, for instance, is preceded by a selective but wide-ranging review of the psychological, sociological, and economic literature on panic over the last century. From a theoretical perspective, conversely, Preda may even have been held back by his historical case study: it remains implicit within the text that his theoretical approach might apply to spheres of technical and professional practice beyond financial markets. Readers interested in both history and social theory, however, will frequently find Preda’s combination of the two rewarding. A close empirical focus on the boundaries of financial markets enables Framing Finance to meet its challenging objective of weaving theory and history together in a mutually constitutive way. The book contains a wealth of original data and theoretical  insights.  Economic  historians,  sociologists  of  finance,  and others with a serious interest in the social role of the modern stock market should all find food for thought within its pages.





Financial Services Authority

Matthew Gill

Matthew Gill works in prudential policy at the Financial Services Authority in

London and writes here in a personal capacity. He holds a PhD in sociology from

the London School of Economics, and has been an interdisciplinary Andrew W.

Mellon postdoctoral fellow at Washington University in Saint Louis. His recent

book, Accountants’ Truth: Knowledge and Ethics in the Financial World, was

published by Oxford University Press (hardback 2009; paperback 2011).

m.gill@alumni.lse.ac.uk

CHAPTER FOUR

Rating Corporations

Swiss bankers are trained to believe that there is a higher goal than making profits. Their priority has been to retain "triple A" credit ratings, the badge of good banking.

rokkrt prkston, Financial Times, 1992

The three supporting arguments about debt rating are germane to the rating of corporations. What are the implications of investment judgment centralization in the corporate world? In what ways does the rating of corporate bonds demonstrate the subjectivity of the rating process and the dominance of instrumental knowledge? How significant is rating to the activities and organization of market institutions? What ideas are articulated in corporate rating, and how best should these be interpreted?

In pursuing these questions, the counterfactual method introduced in chapter 1 is used to contrast rationalist and constructivist accounts. In counterfactual analysis, the factor thought most likely to be causal in the phenomena under consideration is excluded from a second, alternative scenario. In these changed causal conditions, if a different result seems likely, it is probable that the correct causal element was identified in the initial analysis. In developing these scenarios, principles derived from the oppos­ing dimension of the mental framework of rating orthodoxy (table 5 in chapter 3) are deployed. So, if a synchronic-rationalist argument is developed as the primary analy­sis, diachronic-constructivist principles inform the second, counterfactual scenario.

Investment

The kind of bonds which I want to be connected with are those which can be recom­mended without a shadow of a doubt, and without the least subsequent anxiety, as to payment of interest, as it matures.¹

1. J. P. A lorgan, quoted in Ron Chernovv, The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance (New York: Simon and Schuster, 1991), 37.

Rating Corporations 73

The following analysis of investment in relation to corporate rating has three ele­ments: the relationship between rating levels and the typical cost of debt, the nature of the agencies' power, and the agencies' scrutiny of the automobile industry.

Rating and the Cost o f Debt

Ratings affect the cost of issuing debt. Other things being equal, shifts in prevailing interest rates determine the price that issuers must offer to attract funds into their market away from other investment opportunities, such as Treasury bonds, the stock market, and real estate. The particular characteristics of the debt instrument itself also influence its cost; for example, whether a bond is backed by a sinking fund, in which the issuing company sets aside revenue for debt repayment.² However, apart from interest rates and these other issues, the primary factor that distinguishes between different bonds is the creditworthiness of the issuer.

The effect of rating can be understood by comparing the cost of rated and unrated debt, and the difference in yield spread in basis points between highly rated and lower-rated issues. One study indicated that getting a rating can create savings of $0.66 million on a $200 million bond issue, over a twenty-year term.³ Although there is little disagreement about this effect, there is controversy about the impact of subsequent downgrades on yield spreads. It is often unclear whether the market has already anticipated the rating agency's actions and discounted the issuers' cred­itworthiness by the time the agency makes an announcement.⁴ In any case, it is clear that rating has a major influence on the cost of capital to corporations that issue debt.

Rating Power in the Corporate World

The rating constraint and the relatively high interest rates banks charge on loans led to the re-emergence of a high-yield (or junk bond) market in the late 1970s. That market was based in part on the work of Michael Milken, formerly of the invest­ment firm Drexel Burnham Lambert. Milken's arguments about capital access and the credit rating system and his activities as the "junk bond king" during the "junk bond decade" (1977-87) remain the subject of considerable dispute.⁵

During his graduate education at the University of Pennsylvania's Wharton School in Philadelphia, Milken read W. Braddock Hickman's work on returns in the bond market.⁶ Hickman claimed that low-grade or junk bonds promised high

2.    Staff of the New York Institute of Finance, How the Bond Market Works, 1988, 175-76.

3.    Study by Stephen Dafoe, analyst, Canadian Bond Rating Service, Montreal, June 1992.

4.       Interview with Brian I. Neysmith, president, Canadian Bond Rating Service, Montreal, June 16,1992.

5.       See, e.g., Benjamin J. Stein, A License to Steal: The Untold Story of Michael Milken and the Conspiracy to Bilk the Nation (New York: Simon & Schuster, 1992).

6.       W. Braddock I Iickman, Corporate Bond Quality and Investor Experience (Princeton: Prince­ton University Press, 1958).

74 The New Masters, of Capital

yields when held in large numbers in a diversified portfolio by "large permanent investors." He suggested that these returns more than compensated for the addi­tional default risk of the lower-rated debt.⁷ A recent study, which incorporates data from the junk decade, has drawn the stronger conclusion that in the context of a well-diversified portfolio, the risk of lower-grade bonds was actually "no greater" than that of investment grade bonds.⁸

According to Bailey, Milken formed the view that ratings had, over time, "be­come moral absolutes" among investors.⁹The view that ratings are really judgments, as in the diachronic-constructivist account, had been firmly displaced by the ortho­dox notion, derived from the synchronic-rationalist account, that ratings are the result of rational professional processes. Following some of Hickman's conclusions, Milken observed that downgraded bonds "were held in more contempt by investors than they deserved to be." Like some of the investment trade journal writers of the time, Bailey claims Milken saw that the primary problem with the ratings process was that it was too much based on past performance. However, bonds were obliga­tions for future payment, and even an AAA rating was "no guarantee" against a sub­sequent default. According to Bailey, Milken frequently observed that of the twenty-three thousand U.S. companies with sales of more than $3 million, only 5 percent could secure investment grade ratings. The rest had to turn to bank or insur­ance company loans, with their higher interest rates, short-term maturities, and restrictive covenants, or to equity, which was yet more expensive and meant dilut­ing corporate control.¹⁰

Milken saw two major problems with the historical approach the agencies used. First, their focus was on assets and liabilities, or debt/equity ratio analysis, when in his view cash flow really determined a company's ability to service its debt, given that holdings of current debt were always refinanced. Second, he believed the agen­cies were not really interested in the "intangibles" of corporate performance he thought so important: management skill, strategic thinking, and innovation." This rationale underpinned Milken's promotion of junk bonds to clients. He endeavored to show there was more value in these bonds than the agencies, other investors, or even their issuers had believed.

7.     Ibid., 26.

8.       Marshall E. Blume and Donald B. Keim, "Risk and Return Characteristics of Lower-Grade Bonds, 1977-1987," in Edward I. Altman, ed., The High-Yield Debt Market: Investment Perfor­mance and Economic Impact (Homewood, 111.: Dow Jones-Irwin, 1990), 15.

9.       Fenton Bailey, The Junk Bond Revolution: Michael Milken, Wall Street and the Roaring Eight­ies (London: Fourth Estate, 1991), 25.

10.   Ibid., 25,26, 29.

11.     Jesse Kornbluth, Highly Confident: The Crime and Punishment of Michael Milken (New York: William Morrow, 1992), 41; also see Bailey, 1991, 29, and Robert Sobel, Dangerous Dreamers: The Financial Innovators from Charles Merrill to Michael Milken (New York: John Wiley, 1993), 70.

Rating Corporations 75

Milken's career as a bond underwriter and trader came to a close in late 1988, when he was charged and later convicted of a series of SEC disclosure violations, spending two years in a U.S. federal penitentiary.¹²

According to Toffler, Milken attempted to establish a new order in the financial industry. As Toffler saw it, the industry was "hidebound and protected" and a "major barrier to change." Only smokestack, blue-chip industrial "dinosaurs" could get long-term investment capital, because the two rating services "guarded the gates of capital."¹³ Toffler observed that conflict between those (like J. P. Morgan) who wanted to "restrict access to capital so that they themselves could control it," and those like Milken, who supposedly sought a "democratization of capital," has a long history in the United States and elsewhere.¹⁴ Whatever Milken's motivations, the result of the initiative of Milken and others, as Grant has noted, was that "marginal" borrowers "received the benefit of the doubt" in the 1980s.^b This tendency threat­ened to foster an "emerging power structure" that would change the "game," as Grant put it.¹⁶ According to Bruck, "Milken had long professed contempt for the corporate establishment... whose investment grade bonds, as he loved to say, could move in only one direction—down."¹'

The broader movement to change credit standards posed a challenge to estab­lished relationships on Wall Street and in corporate America. In ten years at Drexel, Milken had raised $93 billion, and the junk bond market had grown to $200 billion, serving more than one-thousand, five hundred companies.¹⁸

Milken was no revolutionary. He was a critic of prevailing assumptions about securities and their creditworthiness, applying his own understanding of the diachronic-constructivist principles elaborated in table 5. Although never spelled out in a systematic way, his analysis, following Hickman, was actually a social one. That is, he saw the judgmental and interpretive content in the agencies' rating processes.

During the 1980s, lobbying efforts to review high-yield financing were launched, organized by the Business Roundtable (representing the Fortune top 200 corpora­tions), the American Petroleum Institute, and others. Thirty-seven U.S. states sub­sequently passed restrictive legislation to control leveraged buyouts. Congressional testimony into junk financing suggested that Milken's indictment sealed the fate of

12.  Sobcl, 1993,215.

13.    Alvin Toffler, Powershift: Knowledge, Wealth, and Violence at the Edge oft he Twenty-First Cen­tury (New York: Bantam, 1990), 44^17. (Stephen Gill suggested the relevance ofToffler's work.)

14.  Ibid., 49-50.

15.    James Grant, Money of the Mind: Borrowing and Lending in America from the Civil War to Michael Milken (New York: Farrar Straus Giroux, 1992), 437.

16.   Ibid., 393, quoting a Business Week article, "Power of Wall Street," July 1986.

17.    Connie Bruck, The Predators' Ball: The Inside Story of Drexel Burn ham and the Rise of the Junk Bond Traders (New York: Penguin, 1989), 12.

18.    Glenn Yago, Junk Bonds: How High Yield Securities Restructured Corporate America (New York: Oxford University Press, 1991), 25.

76 The New Masters, of Capital

Drexel's high-yield operations and the use of junk bonds to finance LBOs.'⁹ Wyss observed that the tax deductibility of interest paid on debt and the nondeductibil- ity of dividend payments (on equity) established an incentive structure that favored debt growth in corporate America. Milken's operation was built on these incentives and was evolving into a relationship finance system similar to what Zysman observed in Germany. This would be "inconceivable" in the United States, and "possibly ille­gal." Milken's indictment put a stop to this development. Wyss suggested that the "indictment said to the market, you cannot shift in this direction."²⁰

The testimony of rating agency officials revealed their opposition to what they called the "extreme financial leverage" attributable to the junk bond financing of LBOs in the late 1980s.²' Bachmann emphasized probable constraints on innova­tion, as well as the tendency of managers to sell assets and skimp on strategic plan­ning under such heavy debt loads.²² Grant, a noted Wall Street newsletter publisher and writer, cast the net wider in his testimony. As he saw things, in the 1980s, "Every American with a mailbox was invited to borrow."²³ He blamed this "explosion of the credit supply" on "the long-standing tendency toward the socialization of credit risk that had its roots in the reforms of the early 1930s." Milken had to be understood, Grant implied, in terms of a profligate US government whose net worth in 1988 was negative $2.5 trillion.²⁴ As Wyss noted in response to questions, the government had subsidized junk-financed LBOs as well. First, it had allowed deductibility of inter­est payments.²¹ Second, it had required pension funds' equity assets (but not fixed- income or debt assets) to be marked down to current market value rather than nominal or book value.²⁶

Milken applied heterodox principles to rating, based on an implicit diachronic- constructivist understanding of the rating agencies and their work in the 1970s and 1980s. The effect was to contribute to the disinter mediation of U.S. finance, a

19.     Testimony of David A. Wyss, senior vice president, DRI/McGraw I lill, "High Yield Debt Market/Junk Bonds," hearing before the Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, House of Representatives, 101st Cong., 2nd sess., Mareh 8, 1990 (Washington, DC.: U.S. Government Printing Office, 1990), 3-4.

20.   Ibid., 7, 8,3-4,42.

21.     Testimony of Mark Bachmann, senior vice president, Corporate Finance Department, Standard & Poor's Ratings Group, "High Yield Debt Market/Junk Bonds," hearing before the Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, House of Representatives, 101st Cong., 2nd sess., Mareh 8, 1990 (Washington, D.C.: U.S. Gov­ernment Printing Office, 1990), 12.

22.   Ibid., 13.

23.     Testimony of James Grant, Gram's Interest Rate Observer, "High Yield Debt Market/Junk Bonds," hearing before the Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, House of Representatives, 101st Cong., 2nd sess., Mareh 8, 1990 (Washington, D.C.: US. Government Printing Office, 1990), 18.

24.   Ibid., 22.

25.   Wyss, Mareh 8, 1990, 34.

26.   Ibid., 46-47.

Rating Corporations 77

process that actually expanded the agencies' potential scope of operations. Ironically, if Milken's purpose was to break out of an orthodoxy, the longer-term implication of what he did was to hasten the centralization of finance around debt issuance, for a wider range of companies. Although an immediate problem for the agencies, this challenge had much the same effect as the Asian financial crisis: the rating system did not displace centralization but instead increased its reach.

In a counterfactual scenario, the absence of Milken's alternative intellectual road map about rating and its efficacy would have retarded efforts to build a junk bond market. Disintermediation would have advanced less rapidly because lower-grade companies would have had to finance their operations through bank loans. Rating agencies would be important for a smaller group of companies, the investment cen­tralization process would be less advanced, and the agencies would be less powerful than they otherwise became.

Rating and the Automobile Industry

Rating agencies can at times be understood to "directly intervene in the affairs of a corporation."²⁷ A useful example of this power is the effect of rating downgrades on U.S. automakers, including General Motors (GM) and the Ford Motor Company. These cases do not support an argument that the ratings made were "wrong" or oth­erwise deficient. Instead, by showing the impact of the agencies through ratings, these cases support the claims about investment centralization identified as the first mid-range argument. As argued in the preceding chapters, power and politics are not synonymous with institutionalized politics but pervade social and economic life. In a diachronic-constructivist view of the agencies, ratings are an exercise of power prior to considering the consequences of specific ratings.

At the end of 1991, GM announced a "disastrous $4.5 billion loss" on opera­tions.²⁸ Subsequently, the corporation declared that it would close twenty-one plants and cut seventy-four thousand jobs.²⁹ According to Cox, this action "was intended, by appearing as a token of the corporation's intention to increase competitiveness, to deter a downgrading of its bond rating which would have increased the corpora­tion's cost of borrowing."³⁰ The perceived threat of a downgrade was reinforced by the Wail Street Journal, which noted that the potential rating reduction had "hung heavily" over Robert C. Stempel, GM's chairman, and had "pushed" him to speed restructuring plans.³¹

27.     Beth Mintz and Michael Schwartz, "Sources of Intercorporate Unity," in Schwartz, ed., The Structure of Power in America: The Corporate Elite as a Ruling Class (New York: Holmes & Meier, 1987), 30.

28.    Kathleen Kerwin, James B. Treece, and Zachary Schiller, "GM Is Meaner, But Hardly Leaner," Business Week, October 19, 1992, 30.

29.   Joseph B. White and Bradley A. Stertz, "GM's Debt is Downgraded by Moody's," Wall Street Journal, January 8, 1992, A2.

30.     Robert W. Cox, "Global Restructuring: Making Sense of the Changing International Polit­ical Economy," in Richard Stubbs and Geoffrey R.D. Underhill, eds., Political Economy and the Changing Global Order (Toronto: McClelland & Stewart, 1994), 48.

78 The New Masters, of Capital

However, Stempel's strategy did not work. The corporation was downgraded by Moody's in January 1992, and by Standard & Poor's in Mareh of that year.³² In explaining their action, Moody's officials said the automaker's restructuring plans were unlikely to solve its competitive problems.³³

Pressure on GM from the agencies did not end with these downgradings. According to Judith H. Dobrzynski of Business Week, "The prospect of sinking credit ratings that would deny it access to equity and commercial paper, eventually prompted independent directors" to pressure GM's "old guard," as personified by Chairman Stempel, to quit in late October 1992.³⁴ Subsequently, the agencies issued further warnings of downgrades, including the possibility that GM's debt might be relegated to junk bond status.³⁵ The agencies subsequently acknowledged improve­ment in GM's operating performance. But what seems to have led the agencies to further downgrades in late November 1992 and February 1993 were unfunded pen­sion and medical benefit liabilities. These liabilities threatened to seriously compro­mise GM's balance sheet.³⁶ As S&P observed,

Servicing its massive benefits obligations will be a substantial drain on the company's financial resources—and a significant competitive disadvantage—for the foreseeable future.... GM's unfunded pension liability increased to $14.0 billion at year-end 1992, from $8.4 billion one year earlier. . . . The company has reported a retiree medical lia­bility of $24 billion. . . . Adjusting for these liabilities effectively eliminates GM's con­solidated net worth.³'

Fearing this sort of judgment, which hampered General Motors Acceptance Cor­poration (GM's finance company subsidiary) by raising the cost of commercial paper sales, GM was forced to raise bank loans instead of selling bonds.

31.   White and Stertz, 1992.

32.   Joseph B. White, "General Motors Debt Ratings Are Cut by S&P," Watt Street Journal, Mareh 16, 1992, A2.

33.   White and Stertz, 1992.

34.     Judith H. Dobrzynski, "A GM Postmortem: Lessons for Corporate America," Business Week, November 9, 1992, 87; Kathleen Kerwin, James B. Treece and Zachary Schiller, "Crisis at GM: Turmoil at theTop Reflects the Depth of it Troubles," Business Week, November 9, 1992, 84.

35.    Joseph B. White, "S&P Issues New Warning on GM Stock," Wall Street Journal, Novem­ber 12," 1992, A3.

36.     Ibib., Joseph B. White and NealTemplin, "GM to Disclose More Details on Pension Gap," Wall Street Journal, November 16,1992, A3; Joseph B. White, "GM's Ratings on Debt, Paper Cut by Moody's," Wall Street Journal, November 25, 1992, A3; Kathleen Kerwin, "GM Isn't Running on Fumes—Yet," Business Week, November 30, 1992, 35-36; and Joseph B. White, "GM Ratings Are Downgraded by S&P, But Stock Jumps on Car Sales Data," Wall Street Journal, February 4, 1993, A4. Pension deficits became a systemic issue ten years later: Alexander Jolliffe and Tony las- sell, "Deficits on Pension Funds May Hit Credit Ratings," Financial Times, August 7,2002, 2; Sil­via Ascarelli, "Pension Deficits Threaten Ratings of Twelve Companies," Wall Street Journal Europe, February 10, 2003, Ml.

37.    Standard & Poor's, "General Motors Corp. and Related Entities," Standard & Poor's Cred­it week, February 22, 1993, 44, 46.

Rating Corporations 79

The agency "completed | the largest bank credit package ever," with the attendant extra burden of intermediation.³⁸ GM also sought funds by issuing relatively high-cost equity capital in response to reduced credit ratings on its debt financing.³⁹

Counterfactually, if wc exclude the 1992 and 1993 downgrades, it is unlikely, given the relative cost of bank versus debt finance and the dilution of governance inherent in further issuance of equities, that GM would have sought these alterna­tive forms of financing willingly. The probability is that in the absence of the down­grades GM would have continued to issue debt securities.

The power rating agencies exercise—reflecting investment centralization—was more recently experienced by Ford. Long considered the best managed of the Big Three automobile manufacturers, Ford had embarked on an ambitious strategy in the late 1990s to reinvent the corporation as a consumer company. In the words of its former chief executive officer, Jacques Nasser, Ford "happens to provide automotive products and services."⁴⁰ Nasser planned to use the Internet to transform how the company did business by cutting out dealers, thereby reducing the cost of selling cars. Unfortunately for Nasser, those plans began to come unstuck after 1999, with the dot-com bust and the onset of recession in the United States in 2000. Ford's usual rate of return on total capital of about 10 percent slipped to 9 percent in 1999, and then to 6 percent in 2000.⁴¹ Prior to the September 11, 2001 terrorist attacks, Ford sales had slumped 12.7 percent during July. The market itself slipped 5 percent.⁴²

It was a bad year for the Big Three in 2001. Recession made consumers hungry for deals in the summer and fall, including zero percent financing of new cars and trucks, especially after the terrorist attacks. Each deal of this sort cost around $3,000 per vehicle to the automakers.⁴³ This financing expanded sales and overall sales numbers were not much lower than in 2000, a boom year.⁴⁴ According to S&P, "Sales for full-year 2001 will likely total in the range of 16.2 million to 16.4 million units, making this year the third-best sales year ever. (The best year was 2000, with 17.3 million units; 1999 was the second-best, with 16.9 million units)."⁴⁷ The problem was, sales also grew at Honda, Toyota, and premium European brands, even though

38.    "GM Secures $20.6 Billion in Credit Eines with Banks," Wall Street Journal, May 20, 1993, A3.

39.  Kerwin, November 30, 1992; White, November 12, 1992.

40.   James Flannigan, "Basics, Not Free Loans, Will Help Auto Firms," Los Angeles Times, November 4, 2001, pt. 3, p. 1.

41.  Ibid.

42.    Keith Bradsher, "Ford Weighs Plans to Cut White-Collar Work Force," New York Times, August 17, 2001, sec. C, 1.

43.    Terril Yue Jones, "S&P Drops Boom on Ford, GM," Los Angeles Times, October 16, 2001, pt. 3, p. 1.

44.    Standard & Poor's, "Big 3 Automakers' Credit Quality Deteriorates," October 16, 2001, available at www.standardandpoors.com, accessed February 5, 2001.

45.  Ibid.

80 The New Masters, of Capital

these companies did not offer free financing. Even though the Big Three sold a lot of cars in the last quarter of 2001, little profit was actually made on these vehicles. Tastes were changing, and the imports were tough competition. Foreign makers were producing better SUVs (sport utility vehicles) than the U.S. makers, who had introduced the concept and made most of their profit on these vehicles in the 1990s.

In addition to the market problems that afflicted all the Big Three, Ford had spe­cific problems of its own. Ford incurred liabilities of around S3 billion to replace thirteen million Firestone tires it blamed for accidents on its SUVs and light trucks.⁴⁶ The company faces a series of lawsuits related to these accidents. An S&P analyst observed that the Firestone affair "at least has been a major distraction and affected productivity and quality. . . ."^4/ These quality problems have been signifi­cant. An auto dealer observed that "Ford went from the penthouse to the outhouse on quality," as CEO Nasser pushed component manufacturers to produce at lower price points.⁴⁸

S&P and Moody's began to suggest that a crisis was developing at Ford in the spring of 2001. S&P had put a "negative outlook" on Ford in February. According to Scott Sprinzen, S&P's automotive industry managing director, the agency had been "warning actively" that Ford's rating "could possibly be lowered within a few quarters."⁴⁹ On May 22, Moody's changed the outlook for Ford from stable to neg­ative, anticipating possible future downgrades.¹⁰ Ford responded toward the end of the summer with the announcement of five thousand white-collar layoffs, mainly in the Detroit area, at a cost of $700 million. Ongoing savings were projected at $300 million annually in salaries and other costs.¹' According to Bradsher, S&P was not impressed and said Ford's "efforts to reduce costs have been inadequate."

Immediately, S&P put Ford (and General Motors) on credit watch, with a view to possible downgrade. According to fait, S&P's move reflected "growing misgiv­ings" about profit prospects.⁵² Ford stock sank 8 percent (and GM's lost 5 percent) in reaction.¹³ Moody's began to review Ford "for possible downgrade."⁵⁴ Bonds of

46.    Jack Sirard, Jack Sirard Column, The Sacramento Bee, August 21, 2001, 8, Lexis-Nexis, accessed February 5, 2002.

47.    Terril Yue Jones, "S&P Drops Boom on Ford, GM," Los Angeles Times, October 16, 2001, Part 3,1.

48.    James Flannigan, "Basics, Not Free Loans, Will Help Auto Firms," Los Angeles Times, November 4, 2001, part 3,1.

49.    Keith Bradsher, "Ford Weighs Plans to Cut White-Collar Work Force," The New York Times, August 17, 2001, CI.

50.   www.moodys.com, accessed February 5, 2002.

51.    Keith Bradsher, "Ford to Curtail Auto Production and Cut 5,000 Jobs," The New York Times, August 18, 2001, Al.

52.    Nikki Tait, "Ford Cuts 5,000 Jobs in North America; Automobiles Fierce Competition Forces Carmaker into Restructuring," Financial Times, August 18, 2001, 15.

53.   Ibid.

54.    List of rating actions for Ford Motor Company at www.moodys.com, accessed February 5,2002.

Rating Corporations 81

both companies traded "lower in the secondary market since the agencies' state­ments." ⁵⁵   As often occurs in these situations, the markets anticipated the likely future downgrades following these announcements, considering it, in the words of Morley, a "fait accompli."⁵⁶

S&P acted on October 15 by downgrading outstanding long-term debt from A to BBB+, while Moody's downgraded from A2 to A3 on October 18.⁵⁷ S&P was more bearish than Moody's, signaling that a future rating downgrade, if any, might push the credit into the noninvestment grade or junk bond area. S&P noted, how­ever, that a "further rating change within the next few years was unlikely. Present ratings reflect the expectation that financial performance could be relatively weak for a sustained period.The severity of the S&P move was unexpected and led to a 10 basis point increase in Ford's bond spread.⁵⁹

How did Ford react to the downgrade? Like GM, Ford said in one breath that it was unfortunate and not necessary and, in the next, that "plans" were being devel­oped to take action.⁶⁰ A few days after the rating announcements, Ford said the cor­poration planned to go into the capital market to sell $3 billion in bonds in a market that, since the downgrades of a few days earlier, had widened by between 15 and 20 basis points.⁶¹ Subsequently, Ford changed this plan and decided to sell $7.5 billion worth of securities, just after announcing a $692 million third-quarter loss.⁶² According to Wiggins of the Financial Times, the "positive ruling" by Moody's on Ford Credit, the Ford consumer credit company, encouraged Ford to increase the size of the deal. Moody's, noted Wiggins, saw Ford Credit as a better risk than the automaker itself.⁶³

Although it might seem that Ford was not affected by the ratings actions in 2001, the opposite was actually the case. Ford lost access to the short-term market because its rating fell below the crucial A1 /PI benchmark, required by most money market funds. Ford then had the problem of how to finance its existing short-term borrowings, pushing it into the long-term debt market”⁶⁴

55.     Rebecca Bream, "Ford and GM Ratings in Focus," Financial Times, August 21, 2001, p. 27.

56.     Kevin Morley, co-head of investment grade researeh at Credit Suisse First Boston, quoted in Jenny Wiggins, "Further Rating Fall for Ford Expected," Financial Times, August 24, 2001, p. 25.

57.     As detailed in the respective web sites.

58.     Standard & Poor's, "Ford Motor Company," www.standardandpoors.com, accessed Febru­ary 5, 2002.

59.     Rebecca Bream, "Motor Vehicle Spreads Widen," Financial Times, October 16, 2001, 37.

60.     On GM, see Nikki Tait, "S&P Lowers Debt Ratings on GM and Ford," Financial 'Times, October 16,2001,32; on Ford, see Jamie Butters, "Ford, GM Get Lowered Credit Ratings," Detroit Free Press, October 15, 2001, 7, Lexis-Nexis, accessed February 5, 2002.

61.     Rebecca Bream and Jenny Wiggins, "Ford Plans $3 Billion Bond Issue," Financial Times, October 19,2001,35.

62.     Reuters, "Automaker Plans to Sell $7.5 Billion in Bonds," New York Times, October 20, 2001, sec. C, 4.

63.     Jenny Wiggins, "Ford Doubles Its Bond Issue Size to $7.5 bn," Financial Times, October 20, 2001,18.

82 The New Masters, of Capital

The worsening credit conditions for big issuers like Ford shrank the proportion of short-term assets in money market funds from 36.7 percent in early 2001 to 34.5 percent, as of Octo­ber 2001.⁶⁵

Nasser, Ford's CEO, Internet visionary, and cost-cutter, was removed from his position at the head of the company on October 30, 2001. Chairman William Clay Ford Jr., who took over Nasser's CEO duties, said Ford would return to its "core business" of building cars and trucks.⁶⁶ The financing program continued, espe­cially in the asset-backed market, where Ford sold $5 billion worth of securities in January/'⁷ Soon after, on January 11, Ford announced its Ford Revitalization Plan. The plan included new products, plant capacity reduction, asset sales, reduced div­idends, and about thirty-five thousand job losses for salaried and hourly workers. These actions were projected to improve results by $7 billion annually and by as much as %9 billion by the mid-2000s.⁶⁸

The plan was "not well received" by the agencies. Fitch downgraded, and both Moody's and S&P announced their ratings might be downgraded, too.⁶⁹ S&P affirmed its BBB4-, but it changed the outlook for Ford to negative from stable. On January 16, Moody's downgraded Ford from A3 to Baal. In addition to the automaker, this time Moody's also downgraded Ford Credit and Hertz, Ford's rental car subsidiary. The bad news at Ford continued into 2002 and 2003, despite the turn­around efforts.⁷⁰

Ford's experience with bond rating reflected a more assertive rating industry, underpinned by the growth of capital market financing and its corollary, the central­ization of investment judgment. At first glance, the rationalist view of rating appears most viable in this case. Counterfactually, had rating agencies not closed off Ford's access to the short-term money market in 2001, the policy and personnel shifts at the company in early 2002 may have been delayed. However, the rationalist account does not capture the whole picture. In addition to the closing off of market access, Moody's and S&P's rating actions, warnings, and commentary gave the markets a developing view of Ford.

64.   Lex Column, "Corporate Bonds," Financial Times, October 25, 2001, 24.

65.    Jenny Wiggins, "Funding Dries Up for Commercial Short-Term Paper," Financial Times, October 30,2001,32.

66.   Ford quoted in Flannigan, November 4, 2001.

67.     Adam Tempkin, "Plain Vanilla Tastes Good: Ford's $5 billion ABS Deal Sets the Pace in a Strong Market," Investment Dealers Digest, January 7, 2002, Lexis-Nexis, accessed February 5, 2002.

68.    PR Newswire, "Ford Motor Company Announces Revitalization Plan," January 11, 2002, Lexis-Nexis, accessed February 5, 2002.

69.    The Associated Press State and Local Wire, "Ford Credit Rating Lowered by One Com­pany, on Notice from Two Others," Lexis-Nexis, accessed February 5, 2002.

70.     Norihiko Shirouzu, "Ford's Turnaround Stalls on Downgrade," IVall Street Journal Europe, October 17, 2002, Al; "Junkyard Blues; Ford Motor Company; Fresh Talk That Ford Might Go Bust," Economist, Mareh 15, 2003, 77.

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This view or inter subjective understanding helped to define the context in which the market audience interpreted Ford's operations. Moody's and S&P's actions fell short of being a crisis of fact, but they managed to create an atmosphere of crisis at Ford, this crisis being a social fact. Ford's experi­ence with the agencies can, therefore, in part be understood in constructivist terms.

Knowledge

Rating agencies reproduce an instrumental form of knowledge through their work. This knowledge form reduces the scope for social conflict over ideas to those that fit within narrow purposive assumptions. How knowledge definition occurs is a vital political battle, which takes place before issuers can even begin to debate appropri­ate policy choices and strategies for internal change.

The rise of a ratings "advisory" industry is evidence that instrumental knowl­edge dominates within the rating agencies. Traditionally, investment banks advised their clients on how to present themselves to raters. With the rise of the high-yield market, greater interest on the part of global issuers in selling bonds in the Yankee market, more innovative financing by U.S. and foreign municipalities, and the expansion of domestic bond markets, former rating officials started to establish busi­nesses to take advantage of their knowledge of the rating process. On the whole, these are small enterprises with, at most, a handful of staff. Two of the most prominent are Cantwell & Company in the New York metropolitan area and Evei ling Advisory Services in Frankfurt, Germany.⁷¹ Cantwell publishes an annual survey of attitudes to credit rating.

The advisory services are useful in a context in which rating agencies may meet with a rich multinational on a Tuesday and a mid-size tool-and-die maker the fol­lowing day. Often former raters themselves, the advisers are more likely to under­stand the culture of the rating agencies than investment bankers, immersed as they are in a different environment. The existence of these services underlies the percep­tion that presentation is key to better ratings, judgment is a fundamental part of the rating business, knowledge can be organized in different ways, and the rating process requires knowledge to be presented in ways that meet raters' expectations. More substantially, the existence of advisory firms highlights the increasing pervasiveness of a culture of monitoring.

For rating advisory firms, the cause of their existence is the role of perception and intersubjective understanding in the rating process. If, in an alternative scenario, we remove perception and intersubjectivity, the need for issuers to focus on presen­tation is eliminated (along with these firms).

71. Cantwell's web address is www.askcantwell.com. Ever ling Advisory Services can be found at www.everling.de.

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Confirming the initial causal claim about these firms supports the diachronic-constructivist views of knowledge (the right side of table 5) in the mental framework of rating orthodoxy. These heterodox claims focus on the social dynamics of knowledge, as opposed to the idea that knowl­edge is objective and cross-cultural.

How does the agencies' rating of corporate debt securities promote instrumen­tal knowledge? The agencies make it appear their decisions are the product of a sci­entific process impartial toward all involved parties. As was noted in chapter 2, rating agencies acknowledge in their publications that ratings reflect both qualitative and quantitative information and analysis; the final product is therefore inherently sub­jective. However, the agencies do not make an issue of this subjectivity in their press releases. By not making it clear that their decisions are judgments, they foster the popular myth that rating actions reflect simply the facts revealed by economic and financial analysis. Consequently, they make it seem that any clear-thinking person, possessed of the right sort of knowledge, would come to the same view.

Issuers are also involved in this process. They are not above using rating agencies to justify rapid changes in corporate structure, which may have dire consequences for employees.⁷² This process of "referring back to the agencies" reinforces the notion that their judgments are somehow different and that they have the secret to the "right" way of thinking. Ratings emerge as a valid framework for thinking about corporate decision-making.

The instrumental form of knowledge is at the center of rating analysis, and its logic helps reinforce the synchronic organization of capitalist enterprises. This syn­chronic organization influences everyday life, shaping the experience of work and the expectations of employers and of government. It is as if there is a tension in cap­italism, between private property on the one hand and growth on the other. The rat­ing process normalizes capitalism by regulating it, just as computers do the engines of modern cars. In normalization, the historically diachronic character of capital­ism—its boom and bust, its inherent tendency to hubris followed by crisis—is demonized in an effort to regularize or tame it.'³ The rating experiences of the major telecommunications corporations during 2000 and 2001 demonstrate this tension.

72.     An example of this tendency to use the rating agencies to justify or explain change were pub­lic comments the Chrysler Corporation made in connection with Standard & Poor's 1993 upgrade. The upgrade, to the bottom rungs of investment grade, was an "endorsement" of Chrysler's "strategic direction" and an "acknowledgement of Chrysler's ongoing efforts to improve its cost structure, increase liquidity and reduce leverage"; see "Chrysler Sheds Junk Status at Second Credit Rating Firm," Toronto Star, October 5, 1993, D16.

73.     On these themes, see Joseph A. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper Torchbooks, 1976 [1942]); also see, among other entries, Alexander Ebner, "Schum­peter, Joseph Alois (1883-1950)," in R.J. Barry Jones, ed., Routledge Encyclopedia of International Political Economy (New York: Routledge, 2001), 1368-73.

Rating Corporations 85

Rating and Telecommunications

The 1990s were one of the most prosperous periods in recent history—at least for citizens of the rich countries—even though the decade began with a recession. The United States, Britain, and to a lesser extent Europe, enjoyed relatively high growth and a return to the optimism of the mid-1980s and, before that, of the mid-1950s to mid-1960s. Only Japan failed to return to the growth path. Before the Asian finan­cial crisis of 1997-98, there was much talk about Asian "tigers." The notion of "emerging markets" replaced that of "developing countries," for states like Taiwan, Malaysia, Thailand, and Korea.

The computer made enormous inroads into commerce and education in the 1980s. But the commercialization of the Internet in the mid-1990s brought a huge growth in expectations about the role computers would have in the lives of Western consumers. No longer would the computer be a glorified typewriter. It was net­worked and could talk to other computers. It is hard to exaggerate the enthusiasm that supported the digital revolution, especially in the rich countries, where cheap labor was not a competitive advantage.

Before the Internet revolution, telecommunications companies outside the United States were fairly staid institutions with conservative business strategies. Typically, they had the advantage of a government-protected monopoly and could pick and choose how and when to invest in new technology, at a rate that kept their finances in excellent condition. Once deregulation and liberalization of these mar­kets began in the late 1980s, all of this changed. Competition replaced the old regime of comfortable monopolies, jobs for life, and a three-month wait for a phone line. Suddenly, with the Internet revolution and the explosion of cellular phone use, tech­nology investment looked like a good way to beat the competition. But technology, especially new technology, is expensive, and the investments the phone companies contemplated in the late 1990s were huge.

Moody's estimated the total cost of introducing third-generation cellular phones, which deliver Internet-like services to customers, at around $270 billion. About half of this figure would pay for the technology, and the rest would go for the govern­ment licenses/⁴The subsequent cost of failure was high, too. S&Ps downgrading of France Telecom in July 2002 was estimated to add €110 million to the firm's exist­ing €3.85 billion interest bill for 2002, and €230 million in 2003.⁷⁵

The ratings story starts with Deutsche Telekom's (DT) giant bond issue of June 2000. What was important about DT's $8-15 billion offering is that it was made with a guarantee: the coupon or interest rate paid would rise by 50 basis points (0.5 per­cent) if Deutsche Telekom's rating fell below single A into the BBB territory.

74.    Aline Van Duyn, "DT to Offer Protection for Downgrading," Financial Times, June 16, 2000, page 36.

75.    Vincent Collen and Jamal Henni, "Relating May Cost France Telecom €2bn," Financial Times, July 3, 2002, 21.

86 The New Masters, of Capital

Many fund managers avoid that rating as a matter of policy and, in some localities, as a matter of law. Things became bleaker for DT when Moody's downgraded to Baa3— the lowest investment grade.⁷⁶ DT was following a trend Vodafone started during the $5 billion financing of its takeover of Mannesmann in early 2000. As Van Duyn explains, mergers or big technology investments can be interpreted as pitting the interests of shareholders and bondholders against each other. The benefits to share­holders from beating the competition—growth and increasing profits—are cap­tured (at least in part) by stock price. But bondholders can only ever hope to get back their principal plus the agreed interest payments. Even if a company hits the prover­bial growth jackpot, the debtholders share in none of it." Their only risk is "down­side,"—that the creditworthiness of the issuer will deteriorate—risking default and the loss of their investment.

Pressure from the rating agencies became evident in August 2000, when British Telecom (BT), DT, and the other major telecom players were put under review by both Moody's and S&P.⁷⁸ Fears of a BBB rating delayed BT's $10 billion bond issue/' Moody's downgraded BT, an AAA company until early 1997, from Aal to A2 (but not as low as BBB) on September 6, 2000. This was good news in the sense that a high BBB would have cost BT at least 50 basis points. On $10 billion, 50 basis points equals $50 million a year—a considerable sum for any institution.⁸⁰ Because the bond markets were so nervous about these issues, the telecom companies began to push their investment bankers to come up with bank loans instead.⁸¹ Subse­quently, Moody's did downgrade BT again, on May 10, 2001, to Baal. Mareoni, the telecom equipment manufacturer, had a worse time as the telecom companies held back on other expenditures. Its rating collapsed from investment grade down to B2 junk, in four downgrading events between August 8, 2001 and January 18, 2002.

In 2000 and 2001, the relative newness of the corporate bond market might have contributed to the anxiety in Europe about telecom debt. Moreover, speculative bond issues were new and the volume of debt unprecedented. Before 1990, corporate bond issues were rare. Those that did occur were typically undertaken by conservative companies in a conservative atmosphere.

76.     Stephanie Kirchgaessner and Aline van Duyn, "Moody's Deals Debt Blow to Deutsche Telekom," Financial Times, January 11-12, 2003, 15; Bertrand Benoit, "Investors Unswayed by DT Downgrade," Financial Times, January 14, 2003, 26.

77.    Aline Van Duyn, "Survey—International Mergers and Acquisitions," Financial Times, June 30,2000,9.

78.    Rebecca Bream, "Telecoms Get a Wake-up Call from Worried Bond Markets," Financial 'Times, August 22,2000, 1.

79.     Chris Ayres, "Delay for BT Bond over Credit Worries," Times (London), August 23, 2000. Also see Aline Van Duyn and Rebecca Bream, "Credit Rating Agencies Show Their Teeth," Finan­cial Times, February 27, 2001, 34.

80.    "Rising Debt, Sliding Credibility," Economic Times of India, Lexis-Nexis, accessed Febru­ary 3, 2002.

81.    Charles Pretzlik and Aline Van Duyn, "Indebted Telecoms Face Tough Times Finding New Lenders," Financial Times, October 6, 2000, 28.

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The telecom issues of 2000—2001 really mark the beginnings of creditworthiness disaggregation in Europe, thus creating the basis for further work for the rating agencies. In America, the disaggregation had gone much further. According to Merrill Lynch, telecommunications bonds com­prised a full 18.6 percent of the U.S. high-yield bond market in the year to Septem­ber 30, 2000, ahead of the next-largest industry, cable TV at 8.63 percent.⁸²

A contradiction is evident here. On one side is a fundamentally diachronic cap­italism of dramatically increased competition, technical innovation, and colossal investment of resources. On the other is the instrumental knowledge arising from the synchronic rationalist approach, which above all defends property rights. This contradiction has been noticed by market participants. Beyond obvious comparisons with the Milken era, Ravi Suria, formerly of the investment bank Lehman Broth­ers, suggested that telecom investment can best be compared to other big infrastruc­ture programs in modern history: electricity generation, railroads, highways, airports, ports. These investments were typically undertaken in a closely regulated environment or where monopolies ensured ready guaranteed income (as in the case of the railroads).⁸³

Trying to finance such activities in conditions of globalization, with monitoring institutions like rating agencies—whose way of thinking is grounded in an entirely different logic, indeed a different form of knowledge—signals a profound shift. The hegemony of a social interest linked to growth and expansion gives way to an inter­est more narrowly concerned with the reproduction and safeguarding of its wealth.

The claim here is that the rating agencies produce knowledge actually at odds with the real life of modern capitalism. That world is one of change, typified by growth and decay. The form of knowledge at the heart of rating belongs, in a sense, to a Utopia of static social relations. Counter factually, if we were to remove syn- chronic-rationalist knowledge from rating determinations, actual rating decisions might take into account the circumstances Suria described, and the outcomes would be different. But if the risks of growth are not socialized away from investors, other mechanisms might be sought out by investors to compensate for the lack of instru­mental knowledge in the rating process. This counterfactual scenario supports the synchronic-rationalist account of knowledge. It suggests that before the advent of rating agencies, investors were, as the agencies like to suggest, poorly served.

Governance

The end of the postwar boom and the dynamic of mass production and consump­tion have corroded the economic and political hegemony of OECD institutions in sale difficulties),

82.    Gretchen Morgenson, "Bond Believers See Prelude to a Fall," New York Timea, November 19, 2000, sec. 3, p. 1.

83.  Ibid.

88 The New Masters, of Capital

the postwar era. Once-masterful institutions within civil society, such as commer­cial banks, have had their capacity for exercising authority substantially reduced by the way financial resources have been routed to borrowers. These transforma­tions have made the global economy a "risk culture."⁸⁴ In this era, "The concept of risk becomes fundamental to the way both lay actors and technical specialists organize the social world."⁸⁵ Risk monitoring becomes a central activity of elite reflection. More resources are devoted to "risk profiling—analyzing what, in the current state of knowledge and in current conditions, is the distribution of risks in given milieux of action."⁸⁶ Among the types of risk evaluated are market risk (price fluctuations), liquidity risk (asset operational risk (such as fraud, computer error), exchange rate risk, and event risk (especially takeover threats and opportunities).⁸⁷

In reacting to risk, the rating agencies foster models of corporate organization that challenge established governance structures. The global oligopoly, Moody's and S&P, advocates the capital market-centered system of control, corresponding to Zvsman's model.⁸⁸ Their approach emphasizes the voting mechanism or "approval rating" available in liquid markets. When those with a financial stake in a corpora­tion do the " 'Wall Street walk': sell . . . wise bosses get the message."⁸⁹ As Wood­ward noted of the bond market and the Clinton White House, rating provides a "barometer" with which corporate performance is checked regularly.⁹⁰ This form of governance is different from the German and Japanese systems, where trusted inter­mediaries—banks—traditionally have undertaken the monitoring. Rating agencies constitute a new clearinghouse in which an "approval rating" is constructed and articulated to market agents.

Key ideas of this view of corporate governance can be gleaned from rating pub­lications. S&P includes a series of "organizational considerations" in its corporate criteria.⁹¹ The criteria emphasize that priority should be placed on the "finance func­tion" and that concentration in ownership potentially compromises management.

84.     Giddens, 1991,3; also see Ulrich Beck, Risk Society: Towards a New Modernity, trans. Mark Ritter (Newbury Park, Calif.: Sage, 1992); John Adams, Risk (London: University College Lon­don Press, 1995); and Stephen Gill, "The Global Panopticon? The Neoliberal State, Economic Life, and Democratic Surveillance" Alternatives 20, no. 1 (Jan-Mar 1995): 1-49, 28-29.

85.   Giddens, 1991,3.

86.   Ibid., 114, 119.

87.     See John Plender, "Through a Market, Darkly: Is the Fear That Derivatives Are a Multi- Billion Accident Waiting to Happen Justified?" Financial Times, May 27, 1994, 17, as cited in Gill, 1995, 28-29.

88.    John Zysman, Governments, Markets, and Growth: Financial Systems and the Politics of Indus­trial Change, (Ithaca, NY: Cornell University Press, 1983) 18.

89.   "Watching the Boss: A Survey of Corporate Governance," Economist, January 29, 1994, 4.

90.    Bob Woodward, The Agenda: Inside the Clinton White House (New York: Simon and Schus­ter, 1994), 224.

91.    Standard & Poor's, S&P's Corporate Finance Criteria (New York: Standard & Poor's, 1992), 19.

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The agency also emphasizes the transition from "entrepreneurial or family-bound" to "professional and organizational" corporate control, although it does not define the latter.⁹² S&P's "organizational considerations" correspond to the neoliberal emphasis on "contestability," whereby control is contingent on performance as judged by owners, rather than other nonmaximizing criteria.⁹³

Rating Japanese Banks

Japanese banks are no strangers to the rating agencies. The efforts of Moody's and Standard & Poor's to foster change in the Japanese financial industry go back a decade. Their activities parallel those of the U.S. government. U.S. agitation over Japanese regulation and market practices were evident in the yen-dollar negotiations of the mid-1980s and, more recently, during former Treasury Secretary Paul O'Neill's January 2002 visit to Tokyo, for discussions about the Japanese economic malaise.⁹⁴ As Zysman has observed, the postwar role of banks in Japan was quite dif­ferent from the American model. Banks in Japan have traditionally been much more leveraged than Western institutions, because they support the industrial companies with which they are affiliated. Banks usually have much of their capital in corporate stock and, until recently, did not list this stock at current market value (or mark to market) on their books. Moreover, a history of cooperation between strong and weak banks prevented weaker institutions from going out of business. Subsequent changes in the regulatory system and the collapse of asset prices pose considerable challenges to this pattern.

It is a mistake to imagine that in Japan the rating agencies are able to exercise great power. Despite the poor record of Japanese finance in the past decade, Japan remains a rich country, with great resources and a strong desire to avoid change that gener­ates stark winners and losers. Current bank ratings reflect this approach by antici­pating some sort of government intervention to prop up ailing institutions. That occurred in early 1999, when the Japanese government infused 10 trillion yen into the banking system.⁹⁵

From the beginning of the late-1990s banking crisis, the rating agencies were pushing Japanese banks to change how they did business. A series of downgrades began in 1997, prior to the failure ofYamaichi Securities in November—the biggest corporate collapse since World War II.⁹⁶

92.     Ibid., 19.

93.     "Watching the Boss," January 29, 1994, 5.

94.     Tony Barrett, "U.S. Takes Hard Line on Japan's Bank Crisis," Sunday Business, January 27, 2002, 16.

95.     Standard & Poor's, "Japan Credit Trends 2002: The Downside Deepens," available at www.standardandpoors.com, accessed February 9, 2002, 6.

96.     Moody's began a review of Japanese banks in February of that year; see Gwen Robinson, "Moody's Reviews Japan Credit Banks," Financial Times, February 19, 1997, 33; on Yamaichi Securities, see "Bailout Pressure Rises in Japan," Boston Globe, November 26, 1997, C6.

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These events spurred Japanese banks to use financial innovation rather than balance-sheet improvement to get themselves out of trouble. In one case, S&P refused to rate a deal, leading to poor investor response and abandonment of the project. '' A Japanese regulatory agency found that banks had miscalculated their bad loans by about 10 percent in 1998.⁹⁸

Many aspects of this story only get worse after the government bailout in early 1999. On Mareh 14, 2001, the banking sector lost 5 percent of its stock market value after Fitch announced it was reviewing nineteen Japanese banks for downgrade. Banks were still heavily exposed to the stock market at 150 percent of capital, com­pared to 10-20 perccnt in Western banks.⁹⁹ Fitch observed in the fall of 2001 that bad loan statistics "grossly underestimate" the real level of nonperforming assets. Fitch suggested two things seem to constrain the banks from changing their busi­ness practices. One is a reluctance to get ahead of government and public sentiment toward restructuring and redundancy. The second is the "main bank" system, in which corporations buy bank equity in exchange for better credit terms, reciprocal equity purchases, and promises of support from the bank in bad times."¹⁰

As the fragility of the Japanese system became more apparent, even change seemed dangerous. Moody's signaled in January 2002 that an end to deposit insur­ance in April 2002 might be destabilizing, given the system's "grossly inadequate financial shape." Moody's pushed for a sharing of the burdens of adjustment.¹⁰¹ With the impending changes, forty-six credit unions collapsed in 2001, plus Ishikawa Bank, a larger regional lender.¹⁰² Moody's said subsequently it was losing confidence in the ability of the "Japanese system" to deal with the crisis.¹⁰³ S&P fol­lowed Moody's announcements with further downgrades of its own.¹⁰⁴ In a report on these actions, S&P made it clear that only government intervention could sup­port the existing level of ratings. The agency expected this intervention to continue after deposit protection ended, via the government's crisis management account.¹⁰¹

97.   "Japan Banks Resist Disclosure," Asset Soles Report International, Mareh 23, 1998, 1.

98.    Naoko Nakamae, "Japan's Banks Understated Risk)' Loans, Audit Shows," Financial Times, December 28, 1998,4.

99.   Doug Cameron and Emiko Terazono, "Japan Banks Face Possible Downgrade," Financial Times, Mareh 15, 2001, 34.

100. Fitch Inc., "Running Out of Borrowed Times," Banker; October 1, 2001, n.p., accessed via Lexis-Nexis January 20, 2002.

101. "Moody's Revises Major Japan Banks' Outlook to Negative," Jiji Press Ticker Service, Jan­uary 21, 2002, n.p., accessed via Lexis-Nexis Mareh 10, 2002.

102.  Ken Belson, "Jitters in Japan for Savers and Banks," New York Times, January 23, 2002, sec. W, 1.

103.  "Moody's Cuts Japan Banks' Ratings Outlook," Star (Malaysia), January 25, 2002, n.p., accessed via Lexis-Nexis.

104. "S&P Cuts Ratings on 7 Major Japan Banks, Affirms 4," Jiji Ticker Service, February 5, 2002, n.p., accessed via Lexis-Nexis.

105.  Standard & Poor's, "Ratings on Seven Major Japanese Banks Lowered, Four Affirmed," available at www.standardandpoors.com, accessed February 9, 2002.

Rating Corporations 91

In a wide-ranging report on credit conditions in Japan, S&P cautioned that things would get much worse before they got better and commented on the awareness among Japanese officials and market actors that meaningful credit risk was increas­ingly a fact of life. The report suggested a basic mismatch between assets and returns, and that Japanese banks have been "battling the incessant emergence of new bad loans since the collapse of the bubble economy in 1991 ."^,()6 Elsewhere, S&P observed that simply giving more money to the banks does not solve their problems. Banks had to "reform their lending practices, strengthen their corporate governance and improve their profitability.¹"⁰⁷ Moody's made further downgrades in July 2002.¹⁰⁸ The case of Japanese banks is interesting because it is an example of confronta­tion between the rating agencies and historically entrenched norms and practices. Unfortunately, the problems have not been resolved even after a decade or more of problems. From a counterfactual perspective, if the agencies had not been willing to confront these historically derived norms in the Japanese banking industry, the Japanese government might have been less willing to socialize risk and (partly or temporarily) stabilize the system. This alternative scenario suggests that syn- chronic-rationalist considerations drove these rating actions but that politics had a role, too, in getting government to take responsibility. The diachronic-constructivist view of rating and how it works therefore contributes an important element to understanding the Japanese case.

Conclusions

In this chapter the three mid-range arguments were applied to the rating of corpo­rations. The emphasis of the section on investment was that rating makes a consid­erable difference to the cost of financing. The centralization of investment judgments was demonstrated by the struggle over junk bond financing and the LBO movement. The cases of General Motors and Ford also show the disciplinary effect of these processes in both more narrow rationalist terms and in a wider constructed sense.

In the section on knowledge, it was argued that rating advisory services are evi­dence that the rating process is judgment-filled. The agencies contribute to the con­struction of a synchronic, instrumental form of knowledge, by at all times seeking to appear as if their judgments, like those of auditors, are scientific and impartial.

106. Standard & Poor's, "Japan Credit Trends 2002: The Downside Deepens," available at www.standardandpoors.com, accessed February 9, 2002, 6.

107.        "S&P Cuts Ratings," February 5, 2002, n.p.

108. Bayan Rahman, "Moody's Downgrades Japanese Banks," Financial Times, July 3, 2002, 30. In September 2003, the Japanese government-backed bank recovery agency determined that many banks were overvaluing the collateral of borrowers, suggesting that many institutions could be underprovisioning for their bad loans (David Pilling, "Some Japanese Banks Found To Be Over­valuing Borrowers' Collateral," Financial Times, September 30, 2003, 14).

102 The New Masters of Capita I

There is a tension between the impulse to normalize capitalism around synchronic expert knowledge and the reality that major social investment in infrastructure, like telecommunications, has traditionally taken place in a broader diachronic context.

In the final section, on governance, it was shown that the agencies are key insti­tutions in which responses to risk are developed. The crisis-prone Japanese banks provide an example of how the agencies apply specific views of corporate gover­nance. Next, we examine how the agencies rate municipal governments.