11 Oct Moneyball and Rating Agencies
Moneyball by Michael Lewis is a story of the Oakland Athletics, an under-capitalized baseball team managed by Billy Beane. Unable to afford expensive talent, Beane turns to sabermetrics, baseball statistics that measure in-game performance, to select a lineup of cheaper players with lopsided abilities.
Beane’s own disappointing career as a player was said to validate the notion that raw, backward-looking stats should not be used to value players. He finds success by using quantitative measures to lead the A’s against many better-funded teams, and reaches new highs in the American League rankings.
I have long believed that Moneyball, not The Big Short, tells the real story of the Credit Crisis. Investors relied heavily on credit ratings when they bought structured securities. The credit rating agencies relied on statistics to create and validate their ratings–hence their designation as Nationally Recognized Statistical Rating Organizations. But, the statistics used by the NRSROs to create ratings on structured securities had little or no predictive value.
This technical deficiency didn’t matter for rating corporations, because fundamental credit risk changes slowly, and nobody really relies on ratings to price corporate bonds anymore, anyway. But, structured finance, like baseball, is intrinsically dynamic. So, when you have put a lot of money on securities whose value is changing, you don’t just want to know what a bunch of analysts sitting around a table thought before the deals were issued. You want know how your deals are doing today, and if you’re likely to lose any money.
We mentioned this analogy to Michael Lewis a few years before the Crisis happened.
It doesn’t seem such a difficult concept to grasp now: that the misuse of statistics is at the bottom of the extravagantly wasteful Credit Crisis. If all the people who love the Moneyball story were willing to pressure the government to enforce the statistical integrity of credit ratings, we could start lending once more and rebuild the economy.
But, then again, it’s a different game when well-capitalized professionals grow used to skimming money from a statistically illiterate public.