Economic Circularities and Second-Order Observation: The Reality of Ratings

Can observers observe the economy from the outside? Recent developments in economic sociology tend to blur the classic distinction and combination of economy and society and to move to a model in which the observer is necessarily inside the society he describes. The behavior of financial actors can then be analyzed by combining two concepts: beauty contest and moral hazard -a combination that allows for a translation of their behavior into the terms and the tradition of observation theory. Keynes' beauty contest can be interpreted as a systematic recognition of second-order observation: financial operators primarily observe other observers and what they observe. This observation produces particular circularities -including the insoluble problem of moral hazard, which reproduces Merton's famous model of self-defeating/self-fulfilling prophecies in the field of finance. If finance consists in secondorder observation, however, then its movements can no longer be explained in reference to the world, but in reference to observation and its structures: the reality reference of finance is increasingly provided by ratings, which can only offer information concerning what others observe. The spread of ratings in recent decades and the doubts about their reliability are related to the generalized move of modern society to second-order observation, which produces specific problems and specific puzzles, as well as structures and constraints.