Ratings Agencies a 'Public Bad,' Should Be Tossed: Einhorn

Ratings agencies are not serving a useful purpose and either should be changed dramatically or eliminated, hedge fund manager David Einhorn told CNBC.

David Einhorn
David Einhorn

Agencies such as Moody's, Standard & Poor's and Fitch have become compromised through conflicts of interest with the firms that hire them, said Einhorn, who runs Greenlight Capital and rose to notoriety by railing against Lehman Brothers before the former Wall Street titan collapsed in 2008.

The ratings agencies failed during the subprime mortgage collapse as a source of fundamental credit research, Einhorn believes.In fact, he said, the reputation of the agencies has gotten so bad that savvy players actually bet against the ratings.

"I don't think there's a public good to them. I think basically they're a public bad," he said. "The people who say they don't rely on ratings actually use them a great deal. They use them to identify misrated securities so that they can take advantage of more passive market participants."

Einhorn has taken a short position on Moody's in particular, meaning he believes their shares will fall in the future as the company and its counterparts battle a slew of litigation related to the subprime collapse. Greenlight has $6.8 billion in assets under management.

"They really have to win every single one in order for their equity shareholders to come out OK at the end of this," he said. "I think the odds of them running the table on the litigation are very low."

In a speech last week at the Ira Sohn Investment Conference, Einhorn said the official credit ratings should be eliminated. It was the same conference where he made his short call on Lehman.

"Having so-called better ratings would not insulate us from losses," he said in a separate interview with CNBC. "The solution is to end having official ratings, because the pro-cyclical aspect of centralized ratings is fundamentally destabilizing."

And it's not just companies and individual investors that suffer.

At a time when the world is fearful over sovereign debt problems, particularly in Greece, Spain and other unstable European nations, the ratings agencies can make matters worse by piling on already bad situations.

"When you have a problem they're sort of there to accelerate the problem by putting out an untimely downgrade," Einhorn said. "Many companies have seen that happen and I'm fearful that eventually many governments are going to see that happen."

Congress has been holding hearings through the Financial Crisis Inquiry Commission to rein in the agencies.

One proposal is for the government to tell the firms who they will be rated by, which Einhorn says addresses part of the problem but not the structural issues.

"Ratings agencies didn't just fail in mortgages and structured finance," he said. "They made similar errors rating our largest financial institutions and in all likelihood are still making them in municipal bonds and sovereign bonds...I think Moody's shares are a poor risk-reward."