August 20, 2009
There is one thing I get from Martha’s post. FICO scores are a key intellectual salvo in the “Berkeley controversy” between performativists and institutionalists. Do tools matter? Can devices be political? Martha’s account suggests a resounding yes.
Here’s why. Calculative tools, and specifically the FICO scores, are the key missing link between the interests of bankers and the interests of CDO investors in the credit crisis. In the Fligsteinian account of the crisis, Wall Street bankers induce the credit debacle by switching from selling prime mortgages to selling subprime mortgages… to preserve their profit margins. They certainly pursued their interests. But what the account seems to overlook is that any market transaction requires the agreement of two parties. Granted that bankers were offering crap. The question is – why were subprime investors buying it?
The institutional answer to this is isomorphism. It was junior portfolio managers who probably ended up buying up those subprime securities form greedy bankers. Why? Because their misguided bosses, aware that their rivals were racking up millions by going subprime, told them to do so… or else look for another job. Subprime investors are then the social fools that advanced Wall Street’s interests at the expense of their own.
I find this answer unsatisfactory. As with any diffusion story, it does not explain how the bandwagon got going: once every lemming is falling off the cliff, one can see herding at work. But why did heading for the cliff become a hot trend in the first place? My second misgiving to the “fools” explanation is that it assumes that subprime investors were not actively calculating the risk of their move. Presumably, those greedy bosses did not want to lose their jobs either. So how did they gauge the risks of their bet?
Martha’s work provides the answer. They did so with an instrument they had ready at hand – the FICO scores. And the FICO score was ready for them because it had already been developed to gauge something else entirely different: the risks of legitimate, investment grade prime mortgages.
The argument is so strong that it needs to be made clear: we would not have had a subprime crisis without FICO scores. Only the existence of a calculative tool can explain why one party – Wall Street – was able to advance their interests at the expense of another on a voluntary, free market exchange basis. As Martha writes, a case of “innovation mediated politics.” (For those who are not yet subscribed to the journal, here’s a link to the draft of the paper)
In advancing the empirical basis of this explanation, there are several points that can be pursued.
First, even if we grant that FICO scores allowed subprime investors to engage in a risk-return calculation, it is not a given that the answer would be “buy subprime.” Why was it? Here, Tett and MacKenzie’s account is critical: the problem was the incorrect correlation assumptions in the CDO matrices. So I would like to know more about the relationship between theirs and Martha’s account.
Second, if Martha’s mechanism is indeed at work, we should be able to find other historical parallels. That is, situations in which the forbidden trashy low end of an asset is brought into acceptability by the application of risk management tools used for the legitimate safer half. Are there examples of this? I’d like to suggest the development of junk bonds by Michael Milken in the late 1980s.