This past weekend “This American Life” from Chicago Public Radio did a fantastic piece entitled “The Watchmen” about the credit rating agencies (Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings), the three main companies responsible for grading the financial health and well being of investments.
Recently I was reading the story “The Emperor’s New Clothes” to my young son and I realized that the story was really a parable of the all too common human folly of trust in authority. Not sure if you remember the story but basically there was a very vain emperor (the investment community) who is approached by two shyster tailors (the investment banks) who convince the emperor that they can make him a garment (the structured security) made out of a cloth (the underlying assets) so exclusive that those who are stupid (the general public) or unfit for their positions (the government regulators) cannot see it. The emperor, for fear of appearing stupid and unfit to rule believes that the tailors must know what they are talking about and agrees that indeed the cloth is extremely valuable and gives the tailors all the money the request. The emperor’s ministers (the credit rating agencies) are extremely upset when they do not see the garments, however for fear of appearing useless and losing their privileged positions they too agree that the clothes are wonderful (AAA).
As the story goes, the emperor took his new clothes out on parade and the entire city marveled at the finery, no-one wanting to let it be known that they could not see what the others saw. It was not until a small boy in the crowd shouted out “The Emperor has no clothes!” that everyone began to realize the truth. Never one to have any common sense, the emperor very properly finishes his parade, head held high and ass swinging in the breeze.
Now, my question is… Who in the analogy is the small boy? There were a few “crackpots” or “pessimists” who saw this coming for a long time. But, are they really the ones who finally snapped the city back to reality? No. To my mind the boy in this parable is the subprime home borrowers themselves. By simply trying to participate in the massive scam of economic growth before the whole masquerade came to an end they signaled to the broader market that the whole system was a castle made of sand. It was simply the extension of the ethos of the ruling class (the Wall St. creditors) to the peasants (the vast majority of the indebted working poor) which signaled the end to the illusion.
The moral of the story? It depends on your vested interest I guess. Some people would say the moral is the emperor shouldn’t have been so stupid and it’s his own damn fault, some might say the emperor was directly responsible for making the whole city foolish (bankrupt) and should be brought to the guillotine (not too big to fail), then there are others who believe that if that little brat had just kept his mouth shut and known his place everything would have been fine!
One final little twist is that in the story the Emperor thanks the small boy and takes him on as his new advisor and the Emperor becomes a wise and prudent ruler because each time he tries something stupid the boy tells him so. (democracy free of corporate lobbies and special interests)
But this is all just a silly fairy tale right??