Bad Jargon: Why You Shouldn’t Read S&P’s Reports

The prevalence of mark-to-market accounting, credit-default swaps, and other tools of modern finance allow risk to be repriced quickly as conditions change. This rapid repricing, paradoxically, tends to aggravate short-term instability. But drawing attention to problems as they emerge forces managers to restructure troubled portfolios or entities before dangers can reach explosive proportions and threaten a broad-based implosion of credit quality.

Source: “Putting Today’s Credit Market Risks In Perspective,” a report published by Standard & Poor’s Ratings Services.

Drop a comment if that paragraph made any sense to you.

3 thoughts on “Bad Jargon: Why You Shouldn’t Read S&P’s Reports

  1. All I can say is there was an article on 15th/16th Aug ’07 in Economic Times that S&P’s ratings have lost their credibility as they have been saying all this while that all is well with the US market and all of a sudden there’s a huge sub-prime mortgage tremor which has impacted all the other markets indirectly too.

  2. If you did not understand the stated “paradox”, it seems to be quite straight forward.

    Essentially it means that a lot of people might be trying to manage risk more than what is ideal. My personal opinion is that nowadays, with the advent of computing power, risk management has become a “process”. This is good, but only upto an extent. Unfortunately this is not the case. Take the following as an example. (a complete layman one just for illustration)

    Take a bank which has very less liquid cash (but has lots of it coming in a few days time) and therefore ATMs start running out of cash.

    If people were tracking this bank very closely, there will be a rush to the ATMS triggering more cash withdrawals than necessary. To meet this, the bank might need to break its long term assets, which is of course detrimental to the profits of the bank, which in turn if detrimental to the investors concerned.

    If people were more “patient” and were willing to wait out, the bank would be receiving liquid funds in a few days time and no one would be the loser.

    Basically, the article implies that today’s risk management techniques might trigger “short term panic” which is typically detrimental to the system as a whole.

    Essentially, this has a classic parallel in Game Theory as well. You can also see it manifest itself in the law which provides for filing of bankruptcies. If a company is in what it considers a medium term crisis, it is better for it to file for bankruptcy and protect its fixed / long term assets from its lenders and to repay them back in due course of time. Anyway, thats digressing……

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