Buffett Is Unusually Silent on Rating Agencies
In his annual Berkshire Hathaway letter, Warren E. Buffett recently urged investors to pose tough questions at the shareholders meeting in May. Here is one on the mind of some Buffett watchers: When are you going to fix Moody’s?
Mr. Buffett, known as the Oracle of Omaha, owns a stake of roughly 20 percent in the Moody’s Corporation, parent of one of the three rating agencies that grade debt issued by corporations and banks looking to raise money. In recent months, Moody’s Investors Service and its rivals, Standard & Poor’s and Fitch Ratings, have been prominent in virtually every account of the What Went Wrong horror story that is the financial crisis.
The agencies put their seals of approval on countless subprime mortgage-related securities now commonly described as toxic. The problem, critics contend, is that the agencies were paid by the corporations whose debt they were rating, earning billions in fees and giving the agencies a financial incentive to slap high marks on securities that did not deserve them.
At least 10 of the big companies that failed or were bailed out in the last year had investment-grade ratings when they went belly up—like deathly ill patients bearing clean bills of health.
Moody’s rated Lehman Brothers’ debt A2, putting it squarely in the investment-grade range, days before the company filed for bankruptcy. And Moody’s gave the senior unsecured debt of the American International Group , the insurance behemoth, an Aa3 rating—which is even stronger than A2—the week before the government had to step in and take over the company in September as part of what has become a $170 billion bailout.
Mr. Buffett, 78, one of the world’s richest men, is known for piquant and unsparing criticism of his own performance, as well as the institutional flaws of Wall Street.
But on the subject of the conflict of interest built into the rating agencies’ business model, Mr. Buffett has been uncharacteristically silent — even though that conflict is especially glaring in his case because one of the companies that Moody’s rates is Berkshire . (Its Aaa rating, for the record, is the same as the one from Standard & Poor’s. Fitch downgraded Berkshire for the first time last week.)
Mr. Buffett also seems to have said nothing about a problem that some contend is just as serious and endemic: because ratings are required in so many transactions, the agencies’ inaccurate ratings have no effect on their own bottom lines. And a company that is paid regardless of its performance is a company that will eventually underperform, says Frank Partnoy, a professor of law at the University of San Diego.
“Imagine if you had a rabbi and said, ‘All the laws of kosher depend on whether this rabbi decides if food is kosher or not,’” says Mr. Partnoy, a former derivatives trader. “If the rules say ‘You have to use this rabbi,’ he could be totally wrong and it won’t affect the value of his franchise.”
The rating agencies have been mislabeling the goods for a long time. “A lot of investors have been eating pork recently,” Mr. Partnoy says, “and they’re not too happy about it.”
Mr. Buffett declined to be interviewed for this article. Of course, he has bigger problems on his mind than a company that makes up less than $2 billion of his $127 billion empire.
Berkshire Hathaway, the conglomerate he has run for decades, recently reported its worst year ever: in the fourth quarter, net income fell 96 percent to $117 million.
Short-selling Berkshire Hathaway has recently become a popular strategy, according to a report in Bloomberg News. But betting against Mr. Buffett has never been a profitable strategy in the long term, and the company’s class A shares, which now trade at about $82,000, way off the 52-week high of $147,000, look tempting to many analysts.
Justin Fuller, a partner at Midway Capital Research and Management and author of the blog Buffetologist, says that anyone buying shares of Berkshire now is essentially buying the company at its 2004 price and getting everything that Mr. Buffett acquired since then gratis.
“During the dot-com boom everyone said the old man had lost his touch, because he said he wouldn’t invest in technology companies,” Mr. Fuller says. “When all the brick-and-mortar stock valuations improved, he was lauded as a genius again. He’s able to recognize these manias and waits for the world to go crazy, then comes in as lender of last resort and scoops up assets on the cheap.”
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Mr. Buffett has been scooping. In the last year, he dipped into his multibillion-dollar war chest and also sold some shares in a variety of companies to add to his holdings, which now include preferred shares of Goldman Sachs and General Electric , each of which pays Berkshire 10 percent annually on its investment.
But he has also made an ill-timed deal to buy shares of ConocoPhillips and he acquired two Irish banks that have fared poorly, decisions he describes in his annual letter as a few of the “dumb things” he did in 2008. He does not say much about his stake in Moody’s, and close readers of his letters say he has a history of highlighting some errors in order to obscure subjects he would rather not discuss.
“Warren deserves credit for his candor in admitting mistakes,” says Alice Schroeder, author of “The Snowball,” a biography of Mr. Buffett. “But he chooses which mistakes to discuss. It also pays to listen for the ‘dog that didn’t bark.’ ”
One of those nonbarking dogs, she says, is Moody’s.
America's Life Coach
“He hasn’t discussed publicly what he might be doing to influence the management at this time of crisis,” she says. “Last spring, he knew the rating agencies were deeply involved with the financial crisis. Since he didn’t sell Moody’s then, he should explain what he’s doing to influence the management.”
Moody’s, meanwhile, believes the ratings system may need tinkering but it is not broken.
Michael Adler, a Moody’s spokesman, said the company’s role was simply to assess the odds that a given bond issuer will default—in some cases, taking into account the possibility of government intervention. He said anyone who makes assumptions about the stock price of those issuers based on Moody’s findings about its bonds is misusing the data. (A lot of investors are misusing the data, in that case.)
Mr. Adler also stated in an e-mail message that there were potential conflicts of interest with any ratings system, whether issuers, government or investors pay.
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“Moody’s, for its part, has implemented a series of changes and procedural safeguards to help mitigate potential conflicts and increase the transparency of our analysis,” Mr. Adler wrote. “That said, we believe that a healthy dialogue with regulators and other capital market participants is beneficial.”
But not all models for paying rating agencies are equally risky, says a former Moody’s managing director, Jerome S. Fons—and none is more vulnerable to conflicts of interest than the issuer-pays model.
Mr. Fons, who left the company in 2007 as part of a reorganization, says that Mr. Buffett has long found his connection to Moody’s a little awkward. Mr. Buffett never attended any board meetings, he says, and Berkshire has never bought any additional shares after it acquired its stake in 2000 as part of a deal with Dun & Bradstreet, then its parent company.
It is widely assumed that Mr. Buffett does not use rating agencies at Berkshire: like many leading investors, he employs his own researchers.
“I think he’d love to sell his stake in the company, but he can’t,” Mr. Fons says. “As soon as it was known that he was selling, the value of the company would plunge.”
It is hard to expect any capitalist to push for change that squeezes profits. Then again, Mr. Buffett is not just any capitalist. He is the closest thing that the United States economy has to a life coach.
Typically, chief executives who show up on television after announcing their worst year ever offer some variation of “Don’t worry, America, I’ll do better soon.” When Mr. Buffett appeared on CNBC last week, the subtext was more like, “Don’t worry, America, you’ll do better soon.” (He said that though the economy had “fallen off a cliff,” he was, as ever, bullish about the country’s long-term prospects.)
Mr. Buffett is more than just our reassurer in chief. He also has a history of speaking out against parts of the financial system he considers broken or unfair, even if those parts benefit him. He is one of the few superrich people in favor of steeper estate taxes, for instance.
Given how hard it would be to revamp the rating agencies, and given his credibility and the impact that reform would have on his portfolio, Mr. Buffett may be ideal for a job that no other executive or public official could do: rating agency reform.
“Nobody is better positioned than Buffett,” Mr. Fons says. “If he comes up with a good plan, people would pile on immediately. And if he really is a high-minded idealist, if he wants to leave a meaningful legacy, this would be it.”