CHAPTER FOUR
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.
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.
Rating Corporations 83
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.
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.
84 The New Masters, of Capital
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.
Rating Corporations 87
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.
Rating Corporations 89
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.
90 The New Masters, of Capital
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.
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.
