Risks and Ratings

A Sociological Analysis of the Credit Rating Agencies and

the Global Financial Crisis

i
Abstract

Despite calls for reform of the credit rating industry and the argued need to reduce the
influence of ratings on financial markets following the 2007/8 financial crisis, the major
rating agencies continue to occupy a prominent place in the global financial architecture.
Instead of focusing on the technical or legal aspects of the ratings industry, this dissertation
provides a sociological analysis of the role of the credit rating agencies in contemporary
financial markets. By taking the social nature of markets as a starting point, and situating the
emergence of the rating agencies within wider politico-economic developments over the last
four decades, an analysis of the rating agencies is arrived at which places them at the heart of
a regime of financial value-generation that revolves around the transformation of uncertainty
into measurable risks. After outlining how the agencies, by contributing to a collective belief
in the technical possibility of managing credit risk, formed part of the cognitive and social
framework underpinning the expansion of the complex subprime credit market, the
implications of the near-collapse of global credit markets in 2008 are discussed.

ii
Contents

Introduction 1

Chapter 1 Transformations in global finance - the rise of the credit rating agencies 7

Chapter 2 - Derivatives and structured finance - the formation of a bubble 20

Chapter 3 - After the burst of the bubble - the return of radical uncertainty 33

Conclusion 44

Bibliography 48

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Introduction

Since the start of the global financial crisis, the major credit rating agencies Moodys,

Standard & Poors and Fitch have featured ever more prominently in the global political

economy. Occupying a position of remarkable obscurity as recently as the start of the

century, they have over the last ten years received increasing media attention, due especially

to the role they played in the 2007/8 financial crisis, and the subsequent sovereign debt crisis

in the Eurozone. The increasing centrality of the rating agencies in the global financial

system and their pivotal role in these twin crises of the contemporary capitalist world-

economy inspires a number of questions about these US-based corporations. What or who are

the credit rating agencies? Why do they seem to play such a central role in global financial

markets? To what extent was their rise to prominence a product of wider shifts in the global

economy? And how has their position changed as a result of the biggest financial crisis since

the Great Depression?

In order to answer these questions it will be necessary to look not only at the rating agencies

and their activities, but, first of all, at the social constitution of financial markets in general,

and, secondly, at some essential features of the US and UK-based global financial system as

it has developed over the last four decades. As a basis for examining the role of the major

credit rating agencies in todays political economy, this dissertation will therefore offer a

sociological analysis of how financial markets work. Unlike economic explanations of

markets, which revolve around notions of supply and demand, prices and fundamentals,

liquidity and risk, this analysis will take as its starting point the social basis of the global

trade in financial securities. Such a focus, it is argued, sheds light on some of the reasons why

1
credit rating agencies have come to occupy such an influential position in todays globalised

financial markets.

Discussions within recent social science literature tend to revolve around the political and

social consequences of the role that the major credit rating agencies play in world markets.

Their legitimacy has been questioned, the accuracy of their ratings criticised, and their

ideological nature has been exposed and scrutinized. The literature has identified a number of

important features of the rating agencies and their relation to the structural power of

transnational financial capital, global governance, and the neoliberalisation of international

and national policy-making. In perhaps the most influential work on the rating agencies to

date, Sinclair (2005) argues that by making judgements about the creditworthiness of issuers,

the rating agencies shape market perceptions of what constitutes a risk-free, sound

investment. Due to the authoritative status attributed to the agencies views by market

participants, corporations and governments wishing to access affordable credit, have

increasingly found they have to conform to the models and expectations of the rating

agencies (Sinclair 2005:15-17). Due to their structural and coercive power over national and

international economies, the rating agencies represent a form of private authority in the

sphere of finance (Cutler et al 1999:328; Kerwer 2002).

Why a sociological analysis?

Although the above-mentioned literature describes the ways in which credit rating agencies

are able to exercise a strong influence over economic actors operating in financial markets, it

does not tell us in more than a tautological way how the rating agencies have come to occupy

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this position of authority1. This dissertation therefore takes as its starting point a theoretical

examination of the social foundations of the rating agencies power, with the aim of

elucidating why the judgements of the rating agencies find such resonance in financial

markets, even when their assessments are more than occasionally proven to be misguided

as was strikingly demonstrated by the subprime crisis.

A sociological approach to finance, unlike much of the academic literature on global financial

markets, can help us unpack the reified definition of finance as an autonomous system

governed by clear and transparent rules. More specifically, a sociological approach to global

finance, since it takes as its starting point the discursive constitution of (economic) reality (de

Goede 2005:3), can help us understand the role of credit rating agencies as key producers of

knowledge in financial markets knowledge which not only shapes, but, in important ways,

constitutes the market.

The tacit norms and expectations, as well as the social networks and institutions in which

markets are embedded, have been the object of study of a group of economic sociologists

over the last 25 years (e.g. Beckert 2009; Granovetter 1985; Zelizer 1988)2. Although the

approaches taken by these theorists vary, what unites them is a challenge to the self-evidence

of capitalist market exchange. Unfortunately, in contrast to the sociological study of markets

in goods and services, sociologically-informed analyses of financial markets have to date

been somewhat scarcer. An exception is work by a group of academics associated with the

social studies of finance (Pryke & du Gay 2007:341). In contrast to earlier work in

economic sociology which focused on the institutional and social frameworks in which the
1
According to Sinclair, [m]arket and government actors take account of rating agencies not because the
agencies are right but because they are thought to be an authoritative source of judgements (Sinclair 2005:2). In
short, according to this schema, their authority stems from the fact that they are viewed as authoritative.
2
For a useful overview of the different strands within the sociological study of markets see Fligstein & Dauter
2007.

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market is embedded, this emerging field analyses the social and discursive constitution of

financial models, instruments and devices themselves, be they pricing models (MacKenzie,

Muniesa & Siu 2007), arbitrage trading (Beunza & Stark 2004) or algorithms (Lenglet 2011).

Additionally, theorists have analysed the centrality of trust and emotion in financial exchange

(Pixley 2002, 2003) and the role of ambiguity in the international economy (Best 2008).

The insights offered by these and other contributions to an emerging sociology of finance

promote an understanding of financial markets not as ready-made structures independent of

the perceptions, expectations and beliefs of market participants, but as deeply social

phenomena in which ambiguity, uncertainty, knowledge and calculation play a central role. A

sociologically informed analysis therefore helps us to attain a more profound understanding

of contemporary financial markets as increasingly fragile structures premised on ever more

complex ways of measuring and managing risk. It was this increasing pre-occupation with

risk that propelled the rating agencies forward as key pillars of the current financial

infrastructure.

What do the Credit Rating Agencies do?

The core activity of credit rating agencies, in the strictest term, is to provide an assessment of

the likelihood that a borrower will default on part or all of its debts. A credit rating therefore

constitutes an index of creditworthiness. The scales that the three major credit raters

Moodys Investors Service, Standard & Poors, and Fitch Ratings use to denote their credit

ratings are very similar, and range from the highest grade, AAA or Aaa, to the lowest grade,

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D, for default3. The credit rating awarded to a corporate, municipal or sovereign debtor

influences its cost of borrowing, since a borrowers credit rating is taken into account by

financial market actors when making investment decisions. If an institution has a high credit

rating, and is thus seen as posing a minimal risk to investors, it is able to obtain credit easily

and at low interest rates. Conversely, the lower an issuers credit rating, the more expensive it

becomes for it to raise capital through issuing bonds4. In todays financial markets, it is

almost impossible for firms and institutions to sell debt instruments in open markets without a

credit rating, especially since regulations governing the investment policies of banks and

pension funds are based on the ratings produced by officially recognised credit rating

agencies (NRSROs) which until 2003 comprised only the three dominant rating agencies

mentioned above.

In the 1990s, the agencies also began to rate a growing number of complex mortgage- and

consumer credit-based instruments, as well as associated new credit derivatives an area of

finance which has expanded dramatically over the last decade. In 2006, 54% of Moodys

revenues came from rating these so-called structured finance products (Unterman 2009:13).

Through rating these complex new instruments, the agencies played an important role in the

formation of the subprime bubble which led to the 2007/8 financial crisis, as Chapter 2 will

discuss in more detail.

Brief outline of the dissertation

3 The rating scales of the major rating agencies are divided into investment grade (BBB - / Baa3 or higher) and
below investment grade (BB + / Ba1 and lower). Bonds rated at below investment grade are sometimes called
high yield bonds or, more commonly, junk bonds
4 Bonds function as a specific kind of fixed-income loan to large businesses, governments and financial

institutions. A bond is a contract by which an investor (the creditor) extends to the issuer (the debtor) an amount
of funding, in exchange for which the investor receives a set, usually bi-annual interest payment (the coupon),
throughout the life-span of the bond.

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First of all, in Chapter 1, the wider economic context in which the rating agencies came to the

fore as central pillars of the financial system is outlined. This necessarily brief outline of the

major macroeconomic and political developments shaping global finance over the last four

decades will provide the foundation for a more sociologically informed analysis of the way in

which the tacit networks of trust, knowledge and expectations that have sustained financial

markets since their inception have undergone important transformations over the last 30 years

or so. Following on from this, Chapter 2 examines how the progressively complex

manipulation of risk as a productive cognitive construct underpinned the largest financial

bubble of the last century. Chapter 3 will deal with the fallout of the crisis of trust and

confidence that gripped financial markets when this bubble finally collapsed in 2008,

outlining how a redoubling of efforts at reducing uncertainty through the exercise of financial

discipline has resulted in a punitive culture of financial governance in which the rating

agencies play a central, if somewhat contradictory, role. In the conclusion, finally, the various

analytical threads developed throughout the dissertation will be drawn together and a series

of questions is posed concerning the future of the rating agencies within the wider regime of

financialised capitalism in which they are located.

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Chapter 1 Transformations in global finance - the rise of the credit rating agencies

The rating agencies were not always as influential as they are today. Even ten years ago, few

outside of the financial sector and the economics profession had heard of them. In recent

years, however, their influence on markets has been widely felt, and not a week goes by in

which they do not feature in news headlines. Their rise to prominence was premised on an

important politico-ideological shift, which has over the last four decades transformed the

global economy and transformed finance, which previously occupied a relatively constrained

and supporting function within capitalist accumulation as a whole, into an increasingly

dominant driver of economic growth across the developing world (Epstein 2005:3-4, Harvey

2011:52-7).

At the same time as the deregulated global markets ensuing from this shift created new

possibilities for global investors, they also harboured new uncertainties. The heightened

volatility and complexity associated with the globalisation of financial markets therefore

created a demand for the provision of reliable knowledge to market actors. It was this demand

for information in the face of uncertainty that provided the basis for the commercial success

of the rating agencies. Mainstream accounts of financial change often fail to acknowledge the

centrality of uncertainty to financial markets, and the crucial role that is played, therefore, by

(the producers of) financial knowledge.

Before entering into a more detailed discussion of this interplay between knowledge and

uncertainty in global finance, the key politico-economic developments which led to this

transformation and which therefore underpinned the rise of the rating agencies will first of all

be outlined in broad terms.

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From embedded liberalism to market-based finance

Recent transformations in international finance have been well-documented. The collapse of

the Bretton Woods system between 1968 and 1973, which saw the suspension of the Gold

Standard and the introduction of floating exchange rates, unleashed an era of volatile and

globalised financial flows. During the 1980s capital controls were abolished by most major

capitalist economies, followed by the deliberate de-regulation of the worlds primary

financial markets, starting with London and New York but quickly followed by financial

centres across the globe (Helleiner 1994:9-12). The result was an unprecedented freedom for

financial capital to expand its reach, not merely geographically, but also by integrating itself

more deeply into all aspects of social life (Lapavitsas 2009:116)

The concept of financialised capitalism is often invoked, particularly among Marxist and

other critical theorists, to describe the manner in which, after 1970, national and international

economies became more and more oriented towards financial accumulation. Central to the

argument of heterodox and Marxist economists is the argument that financial liberalisation

was effectively a response to growing imbalances in the global financial system; resultant of

the falling profitability of productive capitalism in the US economy. As Marxist economic

historian Giovanni Arrighi masterfully argues, at times in which capital accumulates beyond

the level at which it can profitably be reinvested in productive or commercial activities,

surplus capital is instead held in liquid form and invested in financial speculation (Arrighi

1994: 227-37;315). As a result, throughout the 1980s and 1990s, as South-east Asia and other

peripheral or semi-peripheral regions of the global economy took over as the worlds prime

manufacturing centres, the economies of the UK, US and Europe became increasingly geared

towards the management of the global flows of surplus capital (Arrighi 1994:312-331).

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The period of competitive deregulation which took hold of the worlds financial markets

during the 1980s stemmed from a heightened competition among the worlds advanced

economies for a slice of this surplus capital. By opening up their economies to foreign capital

and lifting constraints on financial activities, governments hoped to benefit from the waves of

financial capital flowing across borders by enticing them to their native soil (Helleiner

1994:12; Arrighi 1994:310-2).

As regulations which previously constrained capital flows were lifted, a globally integrated

network of open markets emerged, while a shift towards laissez-faire economic policy

based on the thesis of the self-regulating market allowed financial capital to be exchanged

largely without government interference (Argitis & Pitelis 2008). Increasingly, from 1980

onwards, credit would be generated and allocated by free market actors. Firms, aided by

advances in communication and computer technology (Edwards & Mishkin 1995:7)

increasingly sought access to the abundant capital found in open markets in order to finance

their short and long term operations. As a result, market-based financial actors increasingly

took over from banks as prime sources of corporate financing. In order to attract investors

and maintain high share prices under this new competitive regime, many US and European

firms embarked on a wave of mergers and corporate buy-outs, which, because they were

usually financed by the sale of corporate bonds, led to a spike in corporate debt, and an

inflation of financial assets beyond any level seen in the post-war era (Toporowski 2000:13).

At the same time, with traditional banking activities such as mortgage lending and the

underwriting of corporate bonds offering diminishing returns, there was a search among

banks for profitable investment opportunities. In an effort to adapt to the new market-led

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regime, banks sought ways to improve their access to higher-yielding, more risky assets, and

lobbied regulators for permission to reduce reserve ratios and increase leverage (Edwards &

Mishkin 1995:11; Tett 2010). Where they could not eliminate regulations they attempted to

circumvent them by diversifying their operations, merging with other financial institutions in

order to transform themselves into multi-faceted financial institutions able to engage in more

profitable market-based operations, such as investment banking. Another important strategy

was the development of novel financial constructions and instruments for extracting profits

out of debt more of which will be discussed below.

The rise of the rating agencies

Both these developments - the increasing size and scope of financial markets, and the

changing role of banks in the allocation of investment capital, gave rise to a rising demand

for the services of the rating agencies (Sinclair 1994:136-7). On the one hand, the growth of

international bond markets meant that institutional investors were seeking information on the

reliability of an expanding number of different national and international issuers. Due to the

globalisation of financial markets, pension funds and mutual funds were therefore faced with

a growing number of investment options and much more volatile price swings, making it

more and more difficult to carry out the research required to assess the creditworthiness of

different issuers. Credit ratings offered a standardized and convenient way of solving this

problem (Sinclair 2005:3-5), as ratings were widely accepted as reliable indicators of a

debtors likelihood of default, and could thus be used as a basis for pricing different assets.

As such, a reliance on ratings provided an important way for market participants to overcome

the problems posed by the growing complexity and volatility of global markets.

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Concomitantly, as part of a wider trend towards the privatization of financial regulation,

regulatory agencies such as the American Securities and Exchange Commission and the

Basel Accords established by the Bank for International Settlements started to incorporate the

ratings produced by the major rating agencies into the regulations governing the types of

securities institutional investors such as pension funds were allowed to hold (Davies

&Green 2008:68). This shift in regulation meant that bond issuers wishing to market their

securities to large institutional investors needed the blessing of one of the officially

recognised rating agencies in order to enable the latter to fulfil regulatory requirements. This

in effect transformed ratings into regulatory licences required by corporate issuers in order

to sell their bonds (Partnoy 2009), and enabled the rating agencies to start charging debt

issuers hefty fees for rating their securities. This latter practice has received widespread

criticism, especially since the financial crisis, for it creates a conflict of interests between the

rating agencies purported duty to provide an accurate rating, and the desire of their clients to

obtain a rating which is as favourable as possible (Partnoy 2009:441).

The sociology of finance

Despite the recent critique levelled at the rating agencies in the wake of the financial crisis,

their influence on financial markets does not seem to have dissipated. This raises the question

of what it is about the rating agencies that apparently makes them so indispensable to the

financial system. According to proponents of neoclassical economics based as it is on

notions of market efficiency and perfect information (Milonakis & Fine 2009:80-1)

there is no theoretical basis for the existence of the ratings agencies, as market prices are

supposedly established through the rational evaluation of different investment options by a

multitude of market participants. In the eyes of many economists, therefore, the ratings

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agencies are seen as the source of important distortions in the market, as overly optimistic or

pessimistic ratings cause assets to be priced above or below their appropriate market value.

What led to the crisis in the sub-prime market, it is argued, is precisely such a deviation of

market prices from their fundamental value caused, in large part, by the systematic failure

of the rating agencies to properly assess the risks associated with securitised assets (Epstein

& Pollin 2011:8).

Such reasoning assumes, however, that financial assets possess such a thing as a

fundamental market value, independent of what ratings agencies, economists, influential

market traders or the financial press say about the value of financial products. Many recent

accounts of the financial crisis prove problematic, due to the fact that they remain bound by

the limitations inherent in mainstream economics. However refined and sophisticated its

models, a mainstream perspective is structurally unable to account for the self-reflexive

nature of economics as a fundamentally discursive practice, in which description of the

processes which produce economic value have a profound effect on the way objects are

valuated (de Goede 2005:xv).

Sociology, on the other hand, has long acknowledged the inextricable links between the

world and our efforts to understand it, whereas economics is characterised by its continuous

effort to circumvent the ambiguities arising from the self-referential character of the

knowledge it produces, which it achieves by the adoption of several a priori assumptions,

such as the concepts of rational action, perfect information and fundamentals in order to

provide an axiomatic grounding for economic models. On the basis of these assumptions,

modern economics endeavours to subject the inherent uncertainties of the market to its

control by means of the development of sophisticated econometric models designed to

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describe the movement and determination of market prices. However, as Slavoj iek

reminds us, the operation of every formal law is premised on a set of unacknowledged

practical rules and presuppositions (iek 2000:38-41). It is these usually under-emphasised

social foundations of finance which provide important clues to understanding the rating

agencies role in financial markets.

Credit and trust

In contrast to the theories of finance grounded in neoclassical economics, which reify

financial markets as autonomous and clearly defined structures and is merely concerned with

capturing the flow of financial capital in neat mathematical models, a properly sociological

account of finance must take as a starting point of analysis the chimerical qualities of money

and credit. As Georg Simmel, the Wests most eminent philosopher of money reminds us,

money is only deemed valuable to the extent that it is universally recognised as an objectified

representation of value. The extension of credit, which constitutes, in essence, the exchange

of money for a promise of future repayment, can be understood as taking place on an even

higher level of abstraction. Even more so than money, credit thus derives its value from being

socially recognised as a legitimate claim to value (Simmel 2004).

In order for such claims to value to be accepted as legitimate, the credibility of those issuing

credit-notes has to be established beyond doubt. As even a brief survey of European and

American history demonstrates, the construction and maintenance of a stable and universally

accepted monetary and credit system over the last five centuries was a highly problematic

endeavour precisely because the value of financial capital has always been contingent on the

culturally and socially mediated belief in the veracity, legitimacy and reliability of what are,

13
essentially, paper claims (de Goede 2005:xvi-xvii). Hence, the more complex credit systems

became, the more the functioning of financial markets depended on the ability of market

participants to overcome the uncertainty inherent in evaluating the credibility of other market

actors in order to transform the uncertainty stemming from financial capitals chimerical

nature into a hypothesis certain enough to serve as a basis for practical conduct (Simmel

1950, cited in Mllering 2001:405).

Faith, certainty and trust are thus of central importance to the functioning of financial

markets, and the history of finance is, to an important extent, bound up with the effort to

subject the indeterminacies and ambiguities inherent in financial markets to the control of

those in command of financial capital. The institutionalisation of financial exchange in a

framework of formal monetary institutions such as banks, insurance firms, stock and bond

markets, money market funds, pension funds and mutual funds, which are in turn supported

by a wider network of accountants and auditors, government legislation, and the financial

press, serves to normalise financial exchange and renders financial markets sufficiently

predictable and stable for investors to formulate expectations with reasonable certainty (De

Goede 2005:23).

Through the emergence of a complex system of formalised institutions, norms and practices,

the relatively intimate and direct relations of trust and power which for centuries underpinned

financial exchange gradually acquire[d] a social and objective character (Lapavitsas

2003:69). However, the development of this framework was not the natural result of the

gradual evolution of capitalist relations, but the product of several contingent historical and

political shifts. As Giovanni Arrighis account of the history of capitalism demonstrates,

periodic shifts from relatively stable financial conditions to unfettered financial accumulation

14
have in fact characterised the capitalist world from the emergence of the first banks in 15th

century Italy until this day (Arrighi 1994).

A recent example of this was the shift from the embedded liberalism of the post-war era

in which financial flows were tightly controlled by government, financial institutions were

subject to relatively rigid constraints and financial capital was primarily allocated through a

network of local and regional banks, to a much more volatile, decentralised system in which

financial capital was increasingly allocated through open markets (Aglietta & Breton

2001:437). Whereas in the post-war era banks provided the foundation of credibility and

certainty required for the stable circulation of financial capital by means of the careful, case-

to-case evaluation of debtors credit histories, assets, business model, reputation and their

political and social connections (Sinclair 2004:31), the emerging free market system had to

find new ways to manage the inherent uncertainties of financial exchange.

Risks and ratings

De Goede describes how, over the course of the last century, the evolvement of the financial

press, stock market indices and formal regulation managed to transform diverse and

contingent credit practices into a coherent and measurable domain with a life cycle of its

own (de Goede 2005:120). Relatedly, Aglietta & Breton argue that a logic of

homogenization increasingly took hold of financial markets in the second half of the

twentieth century, expressing itself in the standardization of the ways in which financial

assets were produced, categorised and evaluated (Aglietta & Breton 2001:437). This

increasing technologisation of banking practices opened the way for a defining shift in the

sphere of financial exchange: the systematic use of the concept of risk in order to reduce

15
market uncertainty into calculable measures of probability. As soon as markets could be

conceptualised as made up of the random movement of thousands of uniform yet isolated

particles, it became possible to conceive of market prices as being governed by the

mathematical laws of probability (de Goede 2005:126). Henceforth, all manner of

uncertainties could be subsumed under the concept of financial risk, or one of its many

variants, such as credit risk, market risk, counterparty risk, liquidity risk, or operational risk.

Effectively, risk is a category of thought which transforms the indeterminacy of the future

into something which, although it cannot be known in the strict sense of the term, can

nonetheless be calculated to within a known measure of certainty (Sinclair 2005:67). Risk

thus became a key tool through which financial actors endeavoured to subject the

indeterminacy of financial value to their control.

Of course, the transformation of unknowns into calculable risks is precisely what the credit

rating agencies had been doing for decades: using detailed credit histories to calculate the

probability of default of corporate and sovereign borrowers, and capturing the resulting

default risk in a convenient rating. By means of gathering a wealth of complex information

on corporate and sovereign borrowers and transforming it into a concise measure of

creditworthiness, rating agencies produce a reliable measure of risk which serves to

overcome the uncertainties inherent in complex financial transactions. In a credit rating, the

[e]conomic position, social standing, access to power, even the national characteristics and

traits of particular borrowers are subsumed under a single index the purpose of which is to

indicate probability of repayment (Lapavitsas 2003:84).

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Since, in contemporary financial markets, the price of credit is determined by the perceived

risk attached to holding a particular asset, credit ratings can be used to price financial assets

according to the risk they are believed to embody, hence constituting an integral component

in the production of financial value. The rating agencies, by virtue of their ability to alter

perceptions of risk, therefore possess a tremendous influence over the ability of financial

actors to create financial capital (Sinclair 1994).

Authority and belief

Despite the apparent power inherent in the capacity to define perceptions of risk, the

influence of the rating agencies stems not from their privileged access to information or their

superior ability to measure risk. Rather than emanating from the ability to accurately describe

a pre-existing state of affairs, the production of financial knowledge proceeds from the

unique ability of authoritative knowledge to discursively structure the field of financial flows

something which is evidenced by the fact that although credit ratings have on countless

occasions been proven short-sighted and misguided, they nonetheless continue to exercise a

profound influence over financial markets.

The continued belief of financial market participants in the predictive power of the rating

agencies leads them to act in ways which confirm their predictions (Sinclair 2005:17). In the

same way that economics does not describe an already existing economy external to itself,

but brings that economy into being (ManKenzie & Millo 2003:108), rating agencies, as

influential producers of knowledge about financial market instruments (Carruthers 2010),

can therefore be said to possess a performative capacity in credit markets, actualised through

the self-fulfilling nature of economic knowledge.

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As a result of their ability to invoke a sense of control over the uncertainties of the market,

the rating agencies have become part of the infrastructure of the market (Carruthers

2010:160). Not only do the rating agencies foster what Pixley (2002:44) terms impersonal

trust between creditors and debtors, through attuning the organisation and decisions of firms

to the expectations of financiers (Sinclair 2005:65). The rating agencies function as important

nodal points in a collective cognitive machinery which, through the reduction of the complex

array of products on offer in credit markets to a concise and authoritative measure of

creditworthiness, fosters a sense of systemic trust in the overall stability of the financial

system (Carruthers 2010). As Marieke de Goede succinctly states: [p]recisely because it is

based on faith and confidence, the functioning of money and finance requires strong nodal

points of (discursive) authority supporting and maintaining that faith (de Goede 2005:xxiii).

The agencies can therefore be said to represent institutionalized trust agencies (Pixley

2002:53-5).

The technical, calculative nature of the language employed by rating agencies, however, is

often in danger of concealing the profoundly inter-subjective, contingent and political manner

in which knowledge about financial markets is constructed. Efforts to examine the accuracy

and predictive power of credit ratings which have, since the sub-prime crisis, increasingly

come under question (see e.g. Cheng & Neamtiu 2009; Ponce 2012; White 2009) therefore

miss the point. Rather than asking why the credit rating agencies failed to predict the collapse

of the sub-prime mortgage market, the real question lies in the ways in which they managed

to convince market participants of the soundness and safety of the complex instruments at the

heart of the crisis.

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The answer to this question lies in the fact that what the rating agencies really supply to

financial markets is not so much new or better information, but a mechanism for imposing

order on the multiplicity of conflicting data circulating through financial markets.

Contemporary financial markets rely, more than ever before, on the continued faith of market

participants in the value and security of a growing number of increasingly incomprehensible

financial instruments on offer. Rating agencies allow economic actors to suspend their

ignorance about the specific products, and actors implicated in financial exchanges in favour

of trust in the purported authority of credit ratings. However, claims to authoritative

knowledge are at all times dependent on being accepted as such by those it seeks to govern,

and hence require constant articulation and re-articulation (de Goede 2005:7). Appeals to the

scientific nature of the ratings process are part of the effort to place the authoritativeness of

ratings beyond question. Nonetheless, despite the enduring influence of the ratings-based

framework, the recent debate surrounding the legitimacy of the rating agencies demonstrates

that accepted definitions are never completely free from contestation but need to continuously

be re-worked in response to the changing landscape of finance.

This Chapter has sought to demonstrate how certain politico-economic transformations have,

over the course of the last several decades, led to the emergence of an increasingly market-

based financial system, in which the management of uncertainty has become paramount to

sustaining financial profitability. The rating agencies have been at the heart of the effort to

reduce uncertainty through the use of the concept of credit risk. However, due to the social

nature of market perceptions, the measurement of risk is subject to a degree of malleability,

which both affords the concept with a certain transformative capacity, as well as making it

susceptible to constant redefinition.

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Chapter 2 - Derivatives and structured finance - the formation of a bubble

In the previous chapter we saw that, throughout the 1980s and 1990s, the major credit rating

agencies assumed an integral function in credit markets due to their ability to provide market

actors with a means of reducing the uncertainties of financial exchange. The following

chapter will discuss how the trust-invoking knowledge produced by the rating agencies

became of even greater importance during the era of pseudo scientific innovation which took

hold of credit markets from the late 1990s onwards.

During this time, several banks began to develop new techniques for the measurement and

dissemination of default risk. The most important of these techniques, known as securitisation

combined with new derivative products which made it possible for market participants to

effectively trade financial risk provided the foundation for some of the most profitable

market expansions seen in decades. The rating agencies played an instrumental role in the

creation of the new types of securities at the heart of this credit boom. Before the role played

by the rating agencies in what we now recognise as the biggest financial bubble since the

1920s is analysed, I will briefly outline the developments which led to the formation of this

realm of so-called structured finance.

The rise of structured finance

As briefly outlined in the previous chapter, after the dismantling of Bretton Woods an era of

financial liberalisation commenced across the developed economies. After the end of the

Cold War, a renewed sense of confidence in free market capitalism only strenghtened this

20
trend, leading, amongst other key policy decisions, to the repeal of the Glass-Steagall Act in

1999, and the US Commodity Futures Modernization Act in 2000 (Callinicos 2010:61), both

of which expanded the freedom of financial institutions to engage in market-based

operations. The increased power afforded to market actors as a result of these reforms gave

rise to a more market-based allocation of financial capital.

One important consequence of the new increasingly market-based system which emerged

was a change in the way investment options were evaluated. Instead of ascertaining the

creditworthiness of debtors through detailed knowledge of their economic conduct,

creditworthiness was increasingly assessed by means of formalised and technical models. As

the previous chapter argues, the methodology of the credit rating agencies, revolving around

a standardized schematic scale by which default risk is authoritatively assessed, was

emblematic of a more general impetus which, over the last few decades, has increasingly

come to drive the Anglo-American financial system. This effort, which can be summarised as

the search for ways of reducing the plethora of possible future outcomes which might impact

on the value of financial assets to neat statistical models of probability, was also the driving

force behind the rise of structured finance and credit derivatives.

In the 1980s and 1990s, the financial sectors of the US and UK aided by new computer-

assisted statistical techniques witnessed a remarkable growth in the trade of different kinds

of derivatives aimed at hedging against the instabilities inherent in a globalised, highly

integrated market. But there was one kind of uncertainty which financial institutions had

never been able to overcome, namely credit risk: the risk faced by creditors of a debtor

defaulting on his or her obligations. Fuelled by the search for new markets and, some banks

began to explore ways in which they could more effectively manage, and thereby reduce, the

21
default risks posed by the corporate debt held on their books (Tett 2010). One way in which

they achieved this aim was through a technique called securitisation.

Securitisation effectively consists of lumping large volumes of corporate bonds and/or

household loans together, and working out, on the basis of credit ratings, the probable default

rates of this aggregate pool of loans with the help of sophisticated probability models

developed mathematically gifted financial engineers (MacKenzie 2011). On the basis of these

probability curves, an amount of capital was set aside to cover eventual losses caused by

defaults, while coupons were sold to investors which entitled them to a slice of the interest

payments on the pool of loans. The securities which were the result of this process are known

as collateralised debt obligations (CDOs) and asset-backed securities (ABSs, or, when the

underlying loans are mortgages, MBSs).

Although these securitised credit products were initially developed as a way for banks to

reduce the amount of risky assets on a their balance sheet by selling this debt to external

investors, bank executives soon realised the potential for profit in marketing these securitised

instruments to institutional investors, especially CDOs based on mortgage and other kinds of

household debt (Tett 2010: 61-7). Since securitization offered a way in which the risk

inherent in various types of debt could be measured and then tailored to the needs of different

investors, the demand for these products was substantial, especially since banks selling

securitised assets were able to obtain the stamp of approval from the rating agencies, which

often awarded the senior (least risky) tranches of these innovative financial products AA

or even AAA ratings. Credit ratings moreover allowed investors to compare the returns of

these complex securities to those offered by more conventional products (MacKenzie

22
2011:1785), and therefore enabled banks to sell these derivatives to large institutional

investors, such as mutual funds and pension funds.

Hence, banks would be able to remove the credit risk associated with all kinds of consumer

and corporate debt such as mortgages, credit card loans, corporate bonds, or commercial

paper from their balance sheets. Moreover, by purchasing credit default swaps (CDSs)

which enabled financial institutions to effectively sell default risk on to a third party, it was

believed that they could be virtually safeguarded from any losses through defaults within the

underlying pools of debt. To avoid having to hold the unprocessed debt that was to be turned

into CDOs on their own books banks set up so-called structured investment vehicles (SIVs)

to purchase the mortgages and sell the tranches of securities on to investors. The (quasi-)

separation of the default risk associated with the large volumes of raw debt from the banks

own balance sheets meant that they were able to convince regulators to reduce their required

capitalisation ratios, thus leading to dramatically increased leverage across the banking sector

(Tett 2009:114).

In more ways than one, then, financial innovation acted as a powerful stimulus for the pursuit

of self-regulation of the financial sector. Bankers argued that there was no need to subject the

newly founded derivatives sector to state regulation, because credit-based derivatives allowed

risks to be allocated to those best able and willing to take them on, at the appropriate market

price (Dudley & Hubbard 2004:8-12). In this way, the mechanism of the market would

ensure that risks would be spread throughout the financial system in the most efficient way.

23
Sociological analysis

The above account demonstrates clearly how new practices of evaluating and calculating risk

transformed previous uncertainties of the market (the ever-present chance of defaults) into the

foundation for the creation of new forms of financial value. Not only did securitisation have

the effect of transforming uncertain future outcomes into virtual goods to be bought and

sold in the marketplace (Arnoldi 2004:24), by transforming risks arising from the

contingencies of social, political and economic relations into tradable commodities, what

financial engineering effectively strived for was the abstraction of risks from their foundation

in real, substantive economic and social processes. Securitisation was a strategy for the

transformation of the uncertainties inherent in buying and selling claims on future earnings

into defined, calculable risks which were compartmentalised and transformed into abstract

commodities to be traded on financial markets.

The same separation of financial processes from their economic and social foundations can

be discerned in the discourse surrounding the newly emerging field of quantitative finance,

which often tended to invoke images of a self-governing sphere of financial exchange in

which transactions can be fulfilled and prices can be determined ever more efficiently

without the need for formal intervention (e.g. Dudley & Hubbard 2004, IMF 2006). This

narrative overlooks, however, the complex institutional framework of different actors which

underpinned the securitisation market, which included not only banks and their affiliated

entities (SIVs, SPVs), but also, brokerage firms, regulators, and, of course, the credit rating

agencies which produced the ratings used in the statistical probability models on which the

structures of ABSs and CDOs were based. Moreover, far from being the self-evident outcome

24
of a universal evaluative framework, these ratings were arrived at through distinct patterns of

social organisation within the rating agencies themselves (MacKenzie 2010:1795).

Creating value through coding

Since the fundamental value of complex credit products was near-impossible to establish

using conventional pricing models, the construction of these instruments relied on more and

more complex statistical procedures to render their exchange feasible. The evaluative

frameworks by which the rating agencies assessed the risk associated with innovative

financial instruments constituted a central cog in the process of codification and calculation

which enabled the construction and the valuation of these new types of securities (Carruthers

2010:164). Innovative credit-instruments should therefore not merely be understood as

technical entities embedded in, yet relatively autonomous from, distinct social settings. Since

the technical practices which produce financial instruments are themselves profoundly social,

financial instruments are best conceptualised as socio-technical devices (Beunza & Stark

2004), whose value is constituted through the coding and re-coding of knowledge as much as

through the transformation of the technical infrastructures of the market.

Not only was the construction of CDOs ratings-driven in the sense that ratings derived

from historically specific and analytically restrictive data (Carruthers 2010:166) formed the

basis for the determination of the capital requirements underpinning these securities, the

development of an active market for CDOs and ABSs relied heavily on the legitimising

function of the rating agencies, in order to render these complex and, in the eyes of many

investors, mysterious products into knowable and apparently reliable commodities

(Carruthers 2010:172). The innovative financial instruments which made it possible for banks

25
and financial institutions to trade risk did so not because they had somehow discovered a

hitherto untapped potential inherent in financial engineering to transform credit risk from a

liability into an asset, but because the widespread adoption of the securitisation techniques

based on these theories disseminated the belief that the efficient allocation of risk was

possible.

A recent special edition of Theory, Culture and Society, edited by Adrian MacKenzie and

Theo Vurdabakis, outlines the myriad ways in which code is used in the contemporary

economy to (re-)assert control over chance processes, and has thus acquired a productive

capacity (MacKenzie & Vurdabakis 2011). We can observe this capacity in the way in which,

in a kind of self-reinforcing loop, the positive evaluation of (sub-prime-)mortgage based

securities by the rating agencies, enabled the formation of a fast-growing and dynamic market

for securitised instruments, which, in return, kept housing prices high and hence appeared to

confirm the judgement of the rating agencies. The sub-prime bubble proves that knowledge-

producing institutions such as the rating agencies play a central role in the formation of

financial markets, not because they assist investors in obtaining the most accurate and up-to-

date information on the state of the market, but because knowledge creates what it purports

to describe (de Goede 2005:xxii), provided that it is trusted and accepted as accurate by a

sufficient number of people.

Trust in the legitimacy of the rating agencies therefore played a greater role in the formation

of the sub-prime bubble than did the accuracy or otherwise of the ratings they produced. In

fact, it could be said that it was precisely their inaccuracy which provided the foundation for

the development of a multi-billion dollar market in securitised instruments. Hence, the

reasons why analysts of CDOs, armed with advanced degrees, data on the past performance

26
of subprime borrowers, and state-of-the-art modelling technology nonetheless systematically

underestimated the probability of large-scale default (Gerardi et al 2008:70) is not the most

important issue to be addressed. A more important question is how we arrived at a financial

system in which the complex codification and manipulation of risk has become so central to

the way financial value is constructed. To say that the problem with the probability models

lies in the historically limited nature of the ratings on which they were based and the flawed

way in which the models dealt with the problem of correlation (Tett 2010:) does not answer

the question of how a multi-billion market was able to develop on the basis of such seemingly

short-sighted data-management techniques.

Making this possible was the narrowing of the way in which risk has come to be defined in

financial markets a development led, to an important extent, by the rating agencies. The

particular ways in which risk came to be measured during the era of quantitative finance

failed to take into account the inescapably social and interpretive character of markets, and

thus, the inherent ambiguity of market prices. Hence the sub-prime crisis can be argued to be

a result of the fundamental inability of financial knowledge in the neoliberal era to ever fully

overcome the indeterminacy and ambiguity of social and hence, also, financial reality

(Best 2008:358,369). As Vurdabakis and MacKenzie rightly emphasise, coding is not just a

way to tame chance by reducing it to predictability. In the very process of using code to

predict, predictability itself is transformed, generating an inevitable excess (MacKenzie &

Vurdabakis 2011:12).

What the crisis teaches us, therefore, argues Jacqueline Best (2008: 368), is the need for a

greater sensitivity to the limits of financial knowledge. While Best is right to emphasise the

fundamental inability of financial models to fully overcome the indeterminacy of the market

27
 thereby posing a powerful argument for the ultimate futility of the recent flurry of reports,

papers and policy-recommendations attempting to address the failures of banks, regulators

and credit rating agencies to prevent crisis we have to remind ourselves that describing the

sub-prime bust as the result of the failure (of the rating agencies (Carruthers 2010: 165), of

regulation (Levine 2012), etc.) overlooks the fact that, before the crisis, the ratings-based

framework enabled the growth of securitised mortgage-assets from a fledgling market in the

late 1980s to a market worth 6.3 trillion dollars in early 2008 (Barth et al. 2009:1)5.

If analysis of sub-prime securities by the rating agencies and others had not been hampered

by the interpretive, pro-cyclical nature of the risk assessments which they were producing

and their evaluations had not been so over-optimistic, financial institutions would arguably

not have sustained such severe losses as a result of the crisis (Gerardi et al 2008:69), but

neither would they have been able to enjoy such record-breaking profits in the years

preceding it. Hence, while damaging in the long run, it can be argued that the systematic

myopia inherent in the risk-measurement models of banks and rating agencies (Clark 2010)

were in fact enabling factors in the short run, allowing for the expansion of credit markets far

beyond what would have been considered prudent by agents fully aware of the long-term

dangers of unsustainable financial expansion, and thus providing the basis for a period of

sustained income growth for the upper strata of society (Dumnil & Lvy 2011:125-7). In

other words, the risk-management models developed during the 1990s and 2000s proved

extremely useful (MacKenzie & Millo 2009), not despite their inaccuracy, but because of it.

Recent sociological accounts of finance may be more sensitive to the centrality of uncertainty

in financial accumulation, but what they often fail to see is that the inability of risk-

5Moreover, on the basis of this securitised debt, a further notional $62 trillion of credit default swaps was
outstanding in 2007 (Barth et al. 2009:i).

28
management techniques to transcend uncertainty is not a weakness and a limitation, but the

very source of financial profitability. Framing the issue in this way posits the question of

whether the current efforts to regulate the rating agencies, as well as securitisation and

derivatives markets, in order to correct distortions and wrong incentives will ever lead to

a stable financial system freed from the tendency towards bubble-formation, or whether they

merely represent a quick fix. For this reason, rather than framing the sub-prime crisis, as

many commentators have done, as the result of a series of technical flaws in the system,

which could thus be remedied by means of technical and/or regulatory adjustments (Engelen

et al. 2011), I argue that the sub-prime bubble was not an accident, but the inevitable

outcome of the way in which contemporary financial markets attempt to separate financial

returns from the production of economic value in the real economy through the deliberate

manipulation of risk made possible by the creative ambiguity of coding. In fact, the inherent

ambiguity of financial value is precisely what allows financial institutions to exploit

uncertainty as a source of profit, and what ultimately lies behind the ability of credit money

to exceed the constraints of the real economy and form financial bubbles (Fine & Saad-Filho

2004:146-7, Lucarelli 2010).

Rational Exuberance

As argued above, the practices of coding uncertainty in the form of ratings, risk-models and

price indexes, enabled the formulation of a collective belief in the value of credit derivatives.

Yet, the fact that, already in 2006, major banks dealing in securitised sub-prime assets began

to take out hedges on some of their credit portfolios in essence, betting against the

sustainability of the CDO market (Ferguson 2011), suggests that the belief in the real value of

these assets may not have been all that sincere after all, thus leading one to question the

29
assertion that financial actors and rating agencies seriously believed that the [sub-prime

securitisation] market was sustainable (Best 2008:370). The point is, however, that whether

or not banks and rating agencies actually believed in the value of securitised assets did not

matter a great deal, as long as everyone continued to act as if they did.

This cynical, calculating rationality (Das 2011:236-7)6, made possible by the delegation of

valuation to impersonal, calculative techniques, also calls into question the opposition, often

invoked in economic discourse, between rational pricing and irrational exuberance.

Although financial exchange has been mired by periodic bubbles since the 17th century,

contemporary forms of quantified, computerised finance in which prices are established, to an

ever greater extent, by means of standardised calculative practices has created an

unprecedented degree of collective cognitive interdependence between market actors

(Beunza & Stark 2004). In such situations it becomes rational for market participants to

follow price movements even if they do not believe that current price levels are warranted by

fundamentals. As long as securitised credit-based assets continued to be highly rated, and as

long as the other major players kept playing, the securitisation game remained hugely

profitable. In an important sense, therefore, the problem with the sub-prime bubble was that

the exuberance displayed by the various participants in the securitisation chain was, in an

important sense of the term, entirely rational.

Analogously, the opposition between (responsible) investment and speculation has been

problematised by the sub-prime debacle. Even though many investors kept securitised assets

on their books instead of actively trading them, their decision to do so had little to do with

6
In an example illustrating the cynicism pervading many trading rooms during the years before the burst of the
bubble, Michael Lewis records a trader working for Deutsche Bank persuading some of his Wall Street
colleagues to short the self-same mortgage market in which his employer continued to hold substantial
positions (Lewis 2010:93).

30
investment in the strict sense of the term, since the basis for their confidence in the sub-

prime securities market lay not so much in their assessment of the economic and labour

market conditions impacting on mortgagors, but on credit ratings derived from highly

historically specific analysis of default statistics derived from the preceding five decades,

which allowed them to predict that house prices would continue to rise (Lewis 2010:87),

despite the lack of a corresponding rise in wages and a general lack in productive investment

(Dumnil & Lvy 2011:39, Harman 2009:287-8).

Divergence between sphere of finance and the productive economy

The rating agencies thus presided over a system of quantitative finance which furthered a

growing discrepancy between the determination of financial asset prices and developments in

the rest of the economy. Not only is the specific form of knowledge promoted by the rating

agencies [...] instrumental in character, focused on immediate gain rather than growth based

on sustainable social reproduction (Sinclair 2005:60), under the dominance of the ratings-

agencies, financial market prices have been increasingly determined by the perceived risk

embodied by different assets, rather than their potential for long-term, sustainable growth.

The coding of investments in terms of risk has supported a widening of the gap between

financial value generation and the state of the productive economy (Lapavitsas 2009:146).

The increasing divergence of finance from real economic processes which took place during

the early and mid-2000s, fuelled by the adoption of elaborate risk-measurement techniques,

gave rise to a perception that money could be created simply by fine-tuning or altering the

way in which risks are defined (de Goede 2005:141). A Marxist reading, on the other hand,

31
although emphasising the inherent potentiality of financial capital to extract itself

momentarily from the constraints of the productive economy, is able to recognise the

subprime crisis as stark reminder of the fact that financial capital is always ultimately tied to

the production of surplus value in the real economy (Harman 2009:289). Since financial

institutions do not themselves create economic value, but derive their earnings from profits

being generated elsewhere in the economy, a sustained financial expansion such as occurred

during the period 2000-2007, at a time of limited productivity gains and wage stagnation for

the majority of the labour force, was always doomed to eventually result in crisis.

32
Chapter 3 - After the burst of the bubble/the return of radical uncertainty

The previous chapter has outlined how the particular way in which the construction of

financial knowledge and thus financial value have come to hinge on more and more

complex forms of coding risk, which allowed for an expansion of financial asset values far

beyond anything justified by the performance of the non-financial sectors of the developed

world. Inevitably, this unsustainable financial expansion led to a severe financial crisis in

which the fictitious nature of the value created through securitisation and derivatives was

exposed. This Chapter will discuss some of the repercussions of the crisis in light of the

longer-term development of the global economic order, and spell out some of the

contradictions affecting the position of the rating agencies in the current conjecture.

How it all fell apart

The crisis started when, in 2007, default rates on sub-prime mortgages in America began to

rise, causing disruptions in the MBS and CDO markets. A hedge fund with links to Bear

Stearns, a large American investment bank, was one of the first to succumb to the turmoil in

the subprime mortgage market. As defaults increased and banks began to sell repossessed

homes, house prices began to fall, which led to further increases in defaults. In response, the

rating agencies were forced to recognise that many of the complex sub-prime assets they had

previously awarded investment grade ratings were perhaps not as creditworthy as the ratings

suggested, and in July 2007 Moodys and Standard and Poors downgraded a combined total

of over $12 billion of sub-prime mortgage bonds (Tett 2010:206).

33
Although this represented only a small fraction of the total stock of mortgage securities, due

to the opaque nature of the various structured finance markets there was widespread

uncertainty as to how the rise in default rates and the rating downgrades would affect the

price of other types of mortgage securities. The complexity of the way these assets were

constructed and the length of the financial chain linking CDO investors to US households

made it virtually impossible even for expert investors to know how defaults may affect the

cash flows of CDO investors at the other end of the chain (Tett 2010:207). Where before

investors had been able to trust the judgements of the rating agencies, now the sudden

downgrade of securities rated AA or even AAA only months before called into question

the value of all types of asset-backed securities, and caused many risk-averse investors to

simply stop buying these securities altogether (Tett 2010: 207-12).

At first this mainly affected the institutions making up the shadow banking sector, the SPVs

set up by banks in order to move credit holdings off their books. But as the value of asset-

backed securities plummeted and a general solvency crisis threatened the subprime-based

shadow banking sector, many SPVs began to call on their founding banks for emergency

credit lines. Thus, the crisis spilled over into the actual banking sector (Lapavitsas 2009:121)

Credit obligations to SPVs were not the only source of trouble for the banks, however. In

addition to substantial volumes of unprocessed loans and mortgages waiting to be turned into

CDOs, the major banks typically also held large amounts of super-senior risk on their books,

the sudden devaluation of which gave rise to unprecedented losses among some of Americas

banking giants. Between July of 2007 and March 2008, $175 billion dollars disappeared off

the balance sheets of the worlds major banks and apparently dissolved into thin air.

34
Not only did the disruption in the sub-prime mortgage market lead to major losses for a large

number of financial institutions, a more damaging consequence of the sudden contraction in

the mortgage market was the effect it had on overall liquidity in the financial sector

(Lapavitsas 2009:120-1). Far from being an isolated market, it turned out that mortgage-

based securitised assets were traded widely throughout the financial system, and were hence

intricately linked to other markets, such as the credit derivatives market (notably the CDS

market), the money market and the repo market. Asset-backed securities not only constituted

an important source of funding for various financial institutions, but had increasingly begun

to take on money-like qualities due to their wide acceptance as virtually risk-free assets

(Mallaby 2012b). The sudden unwillingness of investors to trade these securities therefore

had grave consequences for overall liquidity in the banking sector, and it was this general

refusal of financial institutions to lend to each other that was the ultimate cause of the

severity of the crisis (Lapavistsas 2009:121).

In order to restore liquidity to markets, the European Central Bank and the US Federal

Reserve made available billions of dollars of cheap credit to the banking sector. This did not

prove sufficient to reverse the tide of panic spreading through markets, however, as one after

the other major financial institution became affected by the turmoil, leading to the failure of

some large hedge funds, mortgage brokers and insurance firms (Lapavitsas 2009:122). After

the collapse of Lehman Brothers, an investment bank at the heart of the US financial system,

the spectre of a total collapse of the financial system loomed, spurring the US and UK

government to inject billions into the banking sector, and agree on a series of bailouts of

several large banking conglomerates which would otherwise most likely have defaulted. At a

35
cost of hundreds of billions of dollars7, a general freeze-up of global financial flows was

reversed and financial Armageddon prevented.

But by this point, the contraction in global credit markets had begun to affect investment in

the real economy, and a wave of corporate bankruptcies ensued. A spike in redundancies,

together with imploding consumer confidence resulted in a massive fall in consumptive

demand. By the end of 2008, a global recession enveloped the worlds developed as well as

developing regions (Harvey 2011:5-6), from which many countries have as yet not managed

to fully recover.

Sociological analysis

As Sinclair points out, the sub-prime mortgage market in 2007 only comprised of around $0.7

trillion worth of assets8, which represented only a tiny fraction of total global capital markets

(which in the same year were valued at $175 trillion). How an unexpected but by no means

devastating disruption in such a relatively small market was able to trigger an economic crisis

of global magnitude was a question which appears to baffle analysts until this day

(reference).

Among other factors, what appeared to cause the contraction in the sub-prime bond market to

have such wide reverberations were its linkages with other markets, as well as a general

excess of leverage in the global financial system, made possible by the application of so-

called risk management techniques. In this way, the complex methods for measuring and

7
The Troubled Asset Relief Programme alone, adopted by the US to buy up toxic debt from banks struggling
to maintain solvency, has been predicted to add $116.8 billion to the federal deficit (Block 2010:16).
8
According to the Securities Industry and Financial Markets Association, the total amount of MBSs (so
including alt-A as well as subprime products) reached $7.4 trillion in the first quarter of 2008 (Crotty 2009:566)

36
manipulating risk developed through financial engineering formed the basis for a tightly

interknitted network of financial claims that spread far beyond the sub-prime mortgage

market alone. The fundamental problem behind the crisis was thus not strictly the mispricing

of subprime credit risk which a brief period of devaluation would have been able to

remedy, considering that the initial rise in defaults was not by all means disastrous (Niccoli &

Marchionne 2012) but the fact that the widespread adoption of complex technical

mechanisms for the manipulation of default risk have undermined the very capacity for

financial intermediaries to assess risk in a relational and socially valid way (Lapavitsas

2009:138-40). In other words, the discrepancy between the size of the initial losses in the

sub-prime mortgage markets and the sheer scale of the crisis they triggered is a symptom of

the intersubjective and fragile nature of the shared practices of coding through which market

prices are determined in todays risk-based financial system. As Sinclair sums up, ..the

essence of the subprime crisis is not illegality or even the bankruptcy of the working poor,

but uncertainty about financial engineering at the heart of the global financial system

(Sinclair 2010:102). Once the codes and frameworks through which knowledge about

financial value was constructed became subject to doubt and uncertainty, a crisis of

confidence spread through credit markets which called into question not only the quality of

subprime debt-based assets, but the very nature of privately created money and credit

(Mallaby 2012b).

Restoring credibility

To an important extent, the various responses (political, economic, ideological) to the

financial crisis should thus be understood as attempting to deal with the way in which the

crisis exposed the cracks in the internal consistency of financial value-generation as it has

37
come to pervade our economic system in the last 30 years or so. Firstly, the massive bailouts

and injections of credit into the system at the height of the crisis can be understood as an

effort by the American, British, and a whole string of other national governments, to fortify

the fragile structure of flimsy private promises constituting the world of complex finance by

means of state guarantees, since the mechanisms previously lending credibility to the credit

system began to unravel (Mallaby 2012b). It was in this way that a crisis of valuation which

began in a relatively remote corner of the US financial system, was transposed onto the

public balance sheets of the US and European states.

Although this solved one immediate problem in that it managed to safeguard the integrity of

the flows of credit sustaining the banking system, the larger and more structural cracks in the

discursive foundations of financial value-creation still plague the system. Tellingly, the

predominant response to this more fundamental crisis has been one of displacement. One

victim of this effort to displace the cause of the crisis have been the rating agencies, which

have been pinpointed as one of the chief culprits for the crisis because of their failure to

accurately assess the risks involved in the securitisation of subprime debt. This politics of

blame represents an ideological effort to transpose the root of the crisis from the inherent

instability of financial accumulation dependent on the artificial manipulation of risk, onto

clearly identifiable actors (Sinclair 2010).

This allows the crisis to be presented as the result of factors which are exogenous to the

market, rather than inherent in the way markets and market prices are constructed. Although

commentators are, of course, right in saying that the rating agencies failed to predict the

probability of large-scale default, the real root of the crisis lies not so much in the fact that the

ratings were inaccurate, but in the more fundamental problem that the cognitive framework

38
which underlay their production had lost some of its previously universally accepted validity,

and was thus no longer able to act as a barrier against uncertainty. The debate surrounding

regulatory reform of the rating agencies are thus best understood as part of a wider effort to

restore credibility to financial governance.

Dealing with uncertainty financial discipline and neoliberal governance

This has not been an easy task. According to financial analysts, inter-bank lending and

general levels of liquidity in the system are still hampered by uncertainty and a general

unwillingness of investors to take risks. Largely, it is the authority of public institutions that

market actors are now looking towards to supply the faith needed to restore the smooth

functioning of the monetary and credit system (Wadhwani 2012). As one commentator puts

it, If the Fed wont take the risk of going beyond what it has tried already, private actors

wont take risks either. Monetary policy is like faith healing. The patient must believe.

(Mallaby 2012a). Worrisome mentions of skittish money market fund managers (Tett

2012), an enduring unwillingness of financial institutions to re-pledge collateral (Singh 2012)

and worsening access to finance for small and medium enterprises across the Eurozone (ECB

2012:5-6), suggest however, that the required faith remains lacking.

What can be observed as a response to this lack of confidence among market participants in

the value of financial instruments is an increasingly coercive exercise of financial discipline

in an effort to re-stabilise expectations in financial markets. The main recipients of this

coercive thrust have been the national governments that stepped in to take on some of the

spiralling private debt by transferring it to public balance sheets during the heights of the

crisis. In a curious displacement of responsibility, instead of taking a critical stance against

39
the financial institutions at the heart of the subprime debacle which are once again reporting

healthy profits, not to mention dealing out generous bonuses to their senior staff the market

is directing its financial discipline against the governments who only a few years ago made

available large amounts of state funds to prevent financial collapse. The European sovereign

debt crisis, although in important respects a direct repercussion of the financial crisis, has

instead been presented as the result of the failure of peripheral European nations to adhere to

the agreed limits on budget deficits and impose the necessary austerity to fulfil their

commitments to their international creditors, as in the case of Greece (Watkins 2012).

Zombies and stagnation

However, unlike previous attempts to revitalise capitalism through a programme of public

asset-stripping, welfare reduction and financial liberalisation, as during the heyday of

neoliberalism in the 1980s, the current response to the economic stagnation seems unlikely to

lead to a period of renewed growth. Instead, global leaders appear to be running around

responding in a seemingly haphazard fashion to an endless row of minor and major financial

emergencies. The lack of decisive action in response to the crisis is demonstrated by the

failure to tackle in more than a cosmetic way the flaws inherent in the rating agency model.

As a result, the rating agencies have not only escaped relatively unscathed from the

regulatory drift of policymakers in the aftermath of the crisis, but have continued to spook

markets and dominate news headlines with their downgrades during 2011 and 2012. The

inability of policymakers to find a way out of recession and the lack of overall sense of

direction which seems to pervade economic debate has prompted certain critical voices to

suggest that the current regime of neoliberal financialised capitalism, far from having

40
approached the end of its dominance, as some have suggested (e.g. Nesvetailova & Palan

2010), has instead into a zombie-like phase (Harman 2009:12, Fine 2008).

In Chapter One we already saw that, as Marxist and heterodox political economists have long

realised, the periodic inflation and collapse of financial bubbles over the last four decades are

to be understood as a continuous effort to stave off, circumvent, and/or displace the effects of

a much more fundamental, long-term crisis of capitalist production (Harvey 2011). The

emergence of the current regime of liberalised finance capitalism was, in many ways, the

response to this crisis. As such, it consisted of two distinct yet related projects: one the one

hand, as we have already seen, there was the re-structuring of financial markets and the

development of new ways of creating financial value in a situation of relatively low growth in

the productive sectors of the economy. Secondly, there was the ideological effort to construct

a coherent discursive framework which could be used as a basis to transform households,

communities, companies and governments into subjects suitable for financial appropriation.

This last project involved a series of ideological shifts: instead of full employment, low

inflation was heralded as the sign of a healthy economy; instead of comprehensive welfare

programmes, infrastructural investment and sound management of financial markets,

deregulation, tight monetary policy and deficit reduction now constituted the definition of

good governance; instead of long-term productivity gains and market share, the price of a

companys shares were increasingly taken as a more appropriate indicator of its performance

(Lazonick & OSullivan 2000).

In short, aside from the increasing complexity and scope of financial markets, the last 30

years have seen the emergence of a financial market civilization, marked by the belief that

markets know what is the best practice for states and policy makers (Argitis & Pitelis

41
2008:6). The rating agencies are one of the sites through which this narrative was articulated

and enforced. The rating agencies, by means of a distinct set of criteria, enforced a particular

view of sound management and sound policy, in which the safeguarding of investors

stakes were prioritised above all else, thus reinforcing what Stephen Gill has called

disciplinary neoliberalism (Gill 1995).

The crisis of neoliberalism or the neoliberalism of the crisis?

For a long time, the financial system was able to transform the risks and uncertainties ensuing

from this turbulent phase in capitalist production into a foundation for financial

accumulation. However, the more crisis-prone and fragile the network of private promises

underpinning the financial system has become over the last few decades, the more forceful

has been the enforcement of this disciplinary discourse in order to ensure that corporate and

public bodies were governed in accordance with the expectations and preferences of financial

institutions (Sinclair 2005:56). It comes as no surprise, then, that after the financial crisis

exposed the fragile nature of the complex structure of expectations which sustained the

system, the coercive nature of financial governance became even more pronounced, with a

growing series of states suffering the punitive force of the market administered, to an

important degree, by the rating agencies. It is questionable, however, whether this effort at

disciplining debtors into more and more austerity will in the end be sufficient to restore

certainty and optimism, or whether it will simply lead to a protraction of economic misery.

Despite the growing evidence that an insistence on deficit reduction above all other

considerations and in the face of growing or stagnant unemployment levels throughout much

of the Eurozone will neither restore growth nor financial sustainability (reference), the rating

42
agencies, along with economic policymakers, have been stuck in the paradigm of austerity

politics, letting ordinary people pay for the excesses of capitalism. Far from signalling its

demise, the financial crisis thus serves as a reminder that neoliberalism is an ideological

framework which arises out of, and is thus inherently designed to adapt to, crisis. In a sense,

neoliberalism and crisis are mutually constitutive (Peck, Theodore & Brenner 2010:95).

Framed in this way, we can begin to conceptualise crisis not as an acute moment of terror

confronting us with the necessity to choose between stark alternatives, but as a more or less

apparent but continually present feature of capitalist society over the last 40 years, involving

continual adjustment to the needs of the market, lest we lose our ability to compete in the

global economy. But todays search for competitiveness does no longer appear to offer the

prospect of a tangible prize for the winners. Instead, averting disaster is but all we can hope

for.

The future of the rating agencies depends on whether the current state of paralysis afflicting

economic and political discourse (Peck, Theodore & Brenner 2010:102) will continue to drag

on, or eventually lead to a redefinition of the key organising concepts of neoliberalism. As

MacKenzie and Vurdubakis point out, if the crisis can be conceptualised as a crisis of coding,

then it is worth remembering that code is also (re-)made through crisis (MacKenzie

&Vurdubakis 2011:12). The protracted nature of the crisis begs the question, however, of

whether the crisis represented a mere temporary glitch in the coherence of the cognitive

framework underlying financial accumulation and which it will thus be able to overcome by

means of a series of minor redefinitions, or whether the excessive waves of risk and

uncertainty set loose during the crisis mean that the current financial architecture, including

43
the rating agencies themselves, will need to be much more radically transformed in order to

avoid being swallowed up in the current.

Conclusion

As this dissertation has sought to demonstrate, a sociological analysis of financial actors,

markets and structures provides important insights into the role of the credit rating agencies

in the global financial system. Aided by a greater sensitivity to the highly social nature of

markets, we have seen how the rise of the credit rating agencies into central institutions in the

neoliberal financial architecture was premised on a series of key transformations in financial

accumulation. First of all, the globalisation of financial markets generated more volatility,

and thus a greater demand for certainty and knowledge about market actors. But more than

that, the very notion of uncertainty in finance has undergone a transformation in recent years.

From presenting an ever-present but accepted threat to future profitability, with the rise of

financial innovation uncertainty increasingly came to be appropriated as a potentially

profitable entity in its own right. This feat was accomplished through the development of new

ways of measuring, classifying, and thence manipulating credit risk, a process in which the

rating agencies were instrumental. Through their provision of reliable and trusted indicators

of creditworthiness and risk, they provided the market with stable expectations of future

earnings, and thus contributed to the tacit fabric of trust and certainty without which the

subprime securitisation market would never have been able to expand so rapidly.

44
However, this carefully constructed and fragile foundation of trust relied on the subsumption

of a complex array of economic, political and social factors into a thing-like index

(Lapavitsas 2007:430), which, in the run-up to the crisis, increasingly took on a life of their

own as judgements on the creditworthiness of individual debtors were transformed, through

the securitisation process, into the basis for increasing amounts of highly leveraged credit.

Financial innovation, coupled with sustained low interest rates, thus enabled financial

accumulation to take place increasingly autonomously from the productive economy, and

provided the foundation for a significant rise in income for those who derived their earnings,

directly or indirectly, from the financial sector.

The rating agencies were among the institutions that profited hugely from this bout of

financial expansion, a fact which has rightly been held against them because of the conflict it

presents for their role as supposedly objective financial watchdogs and gatekeepers.

However, the crisis exposed a more fundamental flaw in the very premise of rating default

risk, which is the fact that, due to the nature of contemporary financial markets, it has become

almost impossible to produce an accurate rating of a debtors creditworthiness since the

ability to repay outstanding debts depends on the cost and amount of further credit available

to the debtor, which themselves depend on these very same credit ratings. This is why those

seeking to regulate the rating agencies into producing more accurate ratings shallow and

half-hearted as this effort has been (Sinclair 2010:104) are not only bound to fall short, they

also miss a very fundamental point: the self-referential and pro-cyclical nature of market

sentiments is already embedded in the rating process, and, as already discussed, hence

precludes the possibility of accurate ratings.

45
Yet, as the above analysis demonstrates, what the rating agencies ultimately provided to

markets during the boom were not so much accurate assessments of default risk, but an

authoritative framework of financial knowledge which supported the belief that it was

possible to measure, dissect, and thereby manage risk. As argued, it was this (perceived)

ability to transform uncertainty into a quantifiable measure of risk that formed the basis for

the elevation of the rating agencies into key pillars of the financial system. But while this

effort to subject risk to tight control may have been beneficial to short-term capital

accumulation during the credit boom, the protracted recession which has had such a

paralysing effect on the economies of the Western world since the collapse of the bubble

suggests that this drive towards minimizing risk and uncertainty at all times has revealed its

limits as a strategy for producing growth. Even if one does not, like the present author, accept

the fact that the current regime of financialised capitalism needs to be thoroughly reformed

because of the detrimental consequences it has for human progress, equality and well-being,

one has to recognise that this refusal, inherent in the cognitive framework of contemporary

finance, to view risk as an inevitable and irreducible aspect of a dynamic economic system

constitutes a major obstacle to the ability of the advanced capitalist economies to revitalise

their productive base and reinstate profitability.

The fact of the matter is, that the quest for income-maximization of the financial rentier

classes, pursued through the generation of large amounts of fictitious capital in an

increasingly fragile financial structure, has produced a growing chasm between the interests

of the upper classes and the long term viability of the national economies in which they are

(for as yet still) based (Dumnil & Lvy 2011:26-7). In the absence of a radically alternative

strategy for generating long-term growth, this contradiction is likely to lead to the slow decay

of the old Western capitalist powers. Even the rating agencies seem to have accepted this

46
apparent inevitability, as their long-term prognoses for the credit ratings of the worlds major

sovereigns illustrate. Already in 2004, Standard & Poors predicted that the ageing societies

and decreasing competitiveness of the Western world would, over the next few decades, lead

to a steady reduction in their creditworthiness (Kreamer 2004).

However, like all analyses produced by the rating agencies, this prognosis was formulated on

the basis of a continuation of current trends. If there is one thing that the financial crisis has

demonstrated, is that such predictions are highly dangerous and are often proven wrong. For

better or for worse, historical development is always subject to a degree of indeterminacy.

Rather than let this fact fill us with fear, we would do well to view this as a cause for

optimism.

47
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