Massively fraudulent credit ratings on mortgage bonds was one of the things if not the thing that precipitated the 2008 housing/economic crisis. Your comment reads like you think bond ratings are mostly accurate but recent history tells us they can't really be trusted.
Yes, massive fraud is one factor that can cause bond defaults to significantly exceed those predicted by credit ratings. Other reasons can include disruptive technology, natural disasters, armed conflict, and other "black swan" events.
What does "priced in" actually mean? A low probability event should be priced in, with the appropriate small but non-zero coefficient. If you get hit by a "black swan event" couldn't you say that your model failed to account for it?
In practice, "black swan" is supposed to mean effects which we underestimate or fail to predict at all. The definition requires not just rarity but an event which hasn't been seen before, and is only only understood in retrospect.
You can try to leave a general hedge for unknowns, like never giving anything >99% long term confidence. But actually pricing black swan problems accurately should be impossible, pretty much by definition.
Ha ha. No they (the people who make real deals/trades/decisions) are just focused on their bonus. Having said that they also care a bit about their bonus. And of course their bonus is important too. Have I missed anything?
I think you're mostly comprehensive there. You missed out two things though: they care about their bonus, and secondly, how that bonus compares to their peers (which could be summarised as "their bonus").
After which they blame the "bad model" and immediately pass on to constructing newer, presumably better models. The fact that maybe, just maybe, trying to model such a thing as a modern-day economic system is futile never crossed these people's minds.
You are being unfairly downmoderated. It is of course not a given that modeling economic systems is impossible, but there is considerable debate as to e.g. what degree prices are random/unpredictable. Everyone agrees the problem is extremely difficult, and it seems somewhat unlikely that there would ever be such thing as a universally applicable financial model. So the remaining question is, of course, to what degree are these models useful? I do not believe there is sufficient evidence to reject the idea that the models are of no utility, especially in the context of failing to price in risks. The contrary position is equally viable, and I would hope anyone with what they considered to be a knock-down argument would do more arguing than knocking down.
Fair point, but the whole impetus for this reporting is that Fitch, one of the big 3 ratings agencies, has raised the issue and acknowledged that the full effect of battery technologies exceeds the time frame of their rating methodologies and so they're urging utilities to diversify into clean energy. I know that doesn't absolve them of past sins or even imply that they can be trusted, it just struck me as ironic that a warning from one is the basis of this post and discussion. They're doing their job here.
Less fraud than you might think. It was more the model where house values would increase or level off not crash, which meant worst case was recovering X% vs 100+% where x% would still cover the outstanding loan. Which allows you to slice and dice very low risks loan value from junk, not because most people are going to pay back, but because the houses have high inherent value.
Their scapegoat was the model. In reality they could probably make a model that gave whatever rating the client desired. That is the fraud, they weren't working in the interest of the investors they were working in the interests of the investment bankers.
In any organization whoever pays the bills tends to get what they value - because they can decide to pay someone else if they feel they're not getting it. All the "arms-length", "neutral" stuff - even if truly well intentioned - get impacted by whatever the payer wants.
In case of mortgage bonds, the bill payers were bond creators who wanted to get the loans off their books as quickly as possible. The buyers should really know better but they too were largely managers whose salary was paid
on % of assets basis with no real downside impact on their own wealth.
