Derivatives and Credit Ratings Agency Double Talk from Buffett

June 3, 2010 - PRLog -- Warren Buffett, the alleged Oracle of Omaha, is supposed to be the investment apostle of the writers' cliche, "write about what you know."

But on Wednesday, St. Warrren of Buffett testified that he did not know all that much about the credit rating market,

even though the holding company he controls, Berkshire Hathaway, is the largest shareholder in Moody’s Investors Service, one of the three companies that dominate the business.

“I’ve never been to Moody’s,” he said at a hearing of the Financial Crisis Inquiry Commission, which is investigating the causes of the global crisis that led to the government bailout of big banks.

“I don’t even know where they’re located. I just know that their business model is extraordinary.”

Mr. Buffett’s remarks about Moody’s business, of course, could be interpreted not so much as a plea of ignorance but rather as a rhetorical flourish meant to put distance between him and the company.

He appeared before the panel under subpoena after first declining an invitation, according to this article in the New York Times.

Pressed to explain how it was possible that he did not have an intimate knowledge of Moody’s operation,

Mr. Buffett offered the example of another of his holdings, Johnson & Johnson.

Citing the recent recall of some of the company’s Tylenol products, he said that he did not know the inner workings of the drug maker’s labs

but that he had faith in the company’s reputation for solid management.

Likewise, he said that Berkshire Hathaway had 260,000 employees and at least one of them was doing something wrong at that moment. He just wished he knew who it was.

To that, Phil Angelides, the commission’s chairman, said, “There’s a difference between that and systemic failure.”

Moody’s was the subject of the daylong hearing, held in New York, as part of the commission’s examination of

why rating agencies like Moody’s, Standard & Poor’s and Fitch gave top investment grades to mortgage-related bonds that were later downgraded to junk after the housing collapse.

Berkshire owns about 13 percent of Moody’s, down from a peak of about 20 percent.

Appearing for two hours of questioning alongside Moody’s chief executive, Raymond W. McDaniel Jr.,

Mr. Buffett declined several times to say that Mr. McDaniel should have been fired for what proved to be inaccurate ratings.

He did say that Mr. McDaniel and Moody’s were no better or worse at predicting the financial fiasco than virtually every other player on Wall Street.

“The entire American public was caught up in the belief that housing prices could not fall dramatically,” Mr. Buffett said.

Moody’s “made the wrong call,” he said, but he counseled humility because “I was wrong on it, too.”

Before the catastrophe started, he called the housing bubble a “bubble-ette,” he said, a term he now regrets:

“It was a four-star bubble.”

Mr. Buffett was the marquee speaker at the event, held in a large room on the second floor of the New School in downtown Manhattan.

The hearing had the feel of a Congressional road show, including the ritual swearing in, as well as a raised platform ringed with blue bunting for the panel members.

Most of those testifying were former or current Moody’s employees, and much of the day was spent exploring the pressures that analysts and managing directors felt to maintain market share against its competitors.

Perhaps not surprisingly, the former employees tended to be more critical than those still on the Moody’s payroll.

Mark Froeba, a onetime senior vice president, told the panel that the culture of Moody’s was transformed after the company was spun off from Dun & Bradstreet in 2000.

Quickly, the quasi-academic atmosphere of Moody’s vanished, he said.

Analysts suddenly felt their first priority was to help the company maintain market share, not get the ratings right.

“Cooperative analysts got good reviews, promotions, higher pay, bigger bonuses, better grants of stock options and restricted stock,” Mr. Froeba said in a prepared statement.

Uncooperative analysts, he added, were often fired.

Mr. Buffett’s large stake in Moody’s has brought him an unusual level of criticism,

largely because he has a history of denouncing practices on Wall Street that he considers reckless or geared toward short-term gains.

The commission’s questioning of Mr. Buffett was not particularly harsh, though panel members were scornful, at times, of Moody’s.

Mr. Angelides said in his opening statement that 89 percent of the securities given a top triple-A rating by Moody’s were later downgraded.

“The miss was huge,” he said. “Ninety percent downgrade. Even the dumbest kid gets 10 percent on the exam.”

Mr. McDaniel fell back on a defense that has been heard often from top executives at rating agencies:

the drop in housing prices was without precedent and therefore all but impossible to predict.

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