Buffett on Moody's and Moats

Smart and celebrated as he is, Warren Buffett often gets a pass when he contradicts himself. He famously called derivatives "weapons of financial mass destruction," but Berkshire Hathaway Inc. (NYSE: BRK) has $63 billion worth on its books and has been lobbying to get them exempted from proposed collateral rules. Over the weekend, at his annual meeting and circus in Omaha, Buffett defended Goldman, Sachs & Co. (NYSE:GS) and its Abacus synthetic collateralized debt obligations, now the target of civil fraud charges from the Securities and Exchange Commission. "It's a little hard for me to get terribly sympathetic for a bank that made a bad credit deal," he said, despite years of muttering about Wall Street's less-than-gentle treatment of clients and counterparties.

But the real jaw-dropper out of Omaha was Buffett's praise of Moody's Investors Service and the other credit raters as "incredibly wonderful businesses." Press accounts didn't give much context, but, well, wouldn't "wonderfully incredible businesses" have been more like it? Yes, Moody's has been a steady moneymaker for many years, a dominant firm in a business that has long resembled an oligarchy. For Moody's, Standard & Poor's and Fitch Ratings, getting paid by the issuers for rating securities has been lucrative indeed -- and never more so than when they were assigning top ratings to the mortgage-backed CDOs that blew such big holes in so many important balance sheets.

Buffett has been exiting his Moody's investment for a while, so maybe he wants to be polite on his way out the door. If you listen to his partner, Charlie Munger, it was all the regulators' fault anyway. But regardless of the regulators' obvious shortcomings, it's hard not to see that Moody's in particular was either astonishingly inept, corrupt, or both. How many passes do Buffett and Munger get -- and how many passes do they give out?

In fact, Buffet's experience with Moody's is more than a reminder that, like other, less-sanctified investors, he often talks his book. It's also evidence of a vulnerability in his investing philosophy -- specifically, his desire that companies he invests in should have "moats" to protect them from serious competition. Moody's had a wide moat around it that allowed it to remain as dominant in credit ratings as, say, the Washington Post Co. (NYSE:WPO) in newspapers and Coca-Cola Co. (NYSE:KO) in soft drinks.

But while moats can be a boon to investors for long periods, they can also give rise to a dangerous complacency. Papers like the Post are still shocked that the Internet is destroying their cozy regional monopolies. Coke has struggled against a variety of non-carbonated drinks. And Moody's established a sort of high-water mark for its own complacency in the face of financial innovation.

Needless to say, Buffett and Munger have long enjoyed their own personal moats, thanks to their brilliant record and shrewd handling of the media. And so even when they engage in gaping inconsistencies, they seem to be immune from skepticism. The question tossed up by this year's Woodstock of Capitalism really is, how deep does the complacency run at Berkshire Hathaway?

Robert Teitelman is the editor in chief of The Deal.