Ruling Against Ratings Firms a 'Game-Changer': Einhorn

A recent court ruling that forced two ratings companies to defend fraud claims is a "game-changer" for the industry, David Einhorn, head of Greenlight Capital, told CNBC.

David Einhorn
David Einhorn

Einhorn, a longtime critic of ratings agencies and an investor famed for calling the implosion of Lehman Brothers last year, said in a live interview that the ruling could cripple ratings companies that may not have the capital to defend against future claims.

In a case lodged against Moody's and McGraw-Hill's Standard & Poor's Ratings Services, a federal judge last week said the ratings of securities distributed to a limited number of investors do not have the same constitutional protections as ratings distributed more widely.

The ruling is significant, Einhorn said, in that it will help shed light on what he considered the reckless way in which ratings companies were evaluating securities and the role that played in bursting the subprime mortgage bubble. The ratings companies said their opinions were protected by the First Amendment.

"Because they violated the trust by loosening standards and concentrated on their fees and their shares, there were ... securities that were created and sold that shouldn't have been and the ratings agencies knew that at the time," he said.

"The result was that people lent money that shouldn't have lent and other people borrowed money that they couldn't repay, and now the whole thing has collapsed and our government has had to pledge really trillions of dollars to bail out the financial system."

Einhorn said he is short both Moody's and McGraw-Hill, meaning he expects both stocks to lose share price. The companies were both lower Tuesday, though some analysts immediately after the ruling said any dips in the shares could represent buying opportunities. Warren Buffett's Berkshire Hathaway trimmed its position in Moody's for the second time since July.

In an earlier CNBC interview, McGraw-Hill President Harold "Terry" McGraw rebutted criticisms of the ratings agencies, pointing out that the judge actually rejected 10 of the 11 claims in the suit. He said the company will defend itself against the lone remaining claim.

"We look forward to getting that one cleared up," McGraw said on CNBC. "Fraud does not live in our house."

He acknowledged that his firm missed the housing collapse but said changes in the business model and regulations will help avoid such mistakes in the future.

"We had the housing recession wrong. The fact that a lot of other people had it wrong doesn't help, but we don't like that," McGraw said. "That's where our problems began."

  • See McGraw's interview here
  • Watch an interview with Sean Egan, of Egan-Jones Ratings