Phil Angelides, the chairman of the government committee that's supposed to figure out the root causes of the 2008 financial collapse, recently told me that he plans to pose a simple, but important question to legendary investor Warren Buffett, who is scheduled to testify before his committee later today: Why would Buffett become one of the biggest investors in rating agency Moody's Investors Service, yet when he does his own analysis for investing he totally ignores the company's ratings?
Lets hope Angelides doesn't chicken out.
The rating agencies, as most people know, were among the chief culprits of the financial crisis, which has its roots in the housing bubble, which the raters missed as well. It's one thing to be wrong, but there is a growing body of evidence that the raters were wrong because they were paid to be wrong.
Keep in mind, the only way all those new mortgages handed out to people who couldn't repay them could be made was if the loans could be taken off the balance sheets of the banks and packaged into mortgage debt. And the only way all those countless billions of mortgage debt could be sold is if the rating agencies placed their coveted triple-A ratings on those bonds.
As we all know, many of those bonds fell into default, many others are now worth just cents on the dollar. The big banks held those securities on their own balance sheets so the when the prices fell, most fell into insolvency. Several like Bear Stearns, Lehman Brothers and Merrill Lynch failed. Baring the great bailout of 2008 and 2009, the rest of the big banks would be extinct as well.
The rating agencies concede they missed the carnage, but as they will testify today, so did everyone else. That's what happens during bubbles; irrational exuberance takeover and rationale people act irrationally.
If only it was that simple. The mortgage bonds and other so-called structured finance deals were among the most lucrative pieces of business for the rating agencies during the housing bubble. Combine that with the fact that the raters are paid by the entities that they are rating, and you have a recipe for disaster--a built-in conflict of interest to inflate their assessments even before the usual pressure from bankers who threatened to select only those agencies that gave them the higher ratings. There is also a growing pool of evidence that the agencies themselves were more-than-willing participants in this sleazy system; rating agency officials say they received pressure not just from those greedy bankers, but from their own greedy supervisors to kiss up to banker demands and rate deals that should have been ignored. One of those raters former Moody's analyst Eric Kolchinsky is testifying to that right now.
And yet, the system survives. Of course, there are a number of fixes to the rating agencies contemplated by Congress. Senator Al Franken wants the government to select which rating agency gets selected to assess a bond deal, the theory being that with the government involved, bankers wouldn't be able to pressure the agencies to mark up their ratings. Sounds good on paper, but consider the following: While the rating agencies may have been negligent in seeing the financial crisis, government regulators were even worse. Our own Treasury Secretary, Tim Geithner, was part of the coterie of economic bureaucrats assuring the public that the financial crisis was just about over when it was just getting revved up in late 2007 when he was president of the New York fed.
Which brings me back to Warren Buffett and Phil Angelides. If Buffett is honest, (and if Angelides has the balls to press him) he will say that he doesn't rely on the ratings of Moody's or any other ratings agency because they're basically worthless. The big raters have missed every market implosion dating at least as far back as the New York City financial crisis in the mid 1970s, and continuing through the Orange County Calif bankruptcy in 1994, the bond market collapse in 1998 that led to the bailout of the giant hedge fund Long-Term Capital Management, and of course to the most recent, mother-of-all collapses, the 2007-2008 financial crisis.
If he's honest, he'll also say that he invests in Moody's (he once owned a 30 percent stake but has since been selling shares) because it's a government sponsored cartel along with its chief competitor Standard & Poor's and Fitch. The government mandates that nearly all the ratings business must go to two "nationally recognized' rating agencies. It means every bond deal that comes to market must be rating by any two of the agencies that split the massive fees on billions of bond deals each year. In other words it's a license to steal.
It's also a license to produce crummy ratings, I hope Buffett points out. Aside from bankers playing one rating agency off another, when was the last time a business cartel, created and protected by the government did anything well? Not the post office, not the department of motor vehicles and certainly not the all those Wall Street firms that were considered Too Big To Fail and went out and took so much risk they blew themselves up, and of course, our entire economy.
If Buffett really levels with Angelides he'll say there's no reason to have rating agencies and given the weight of his words, that could be the final nail in the coffin of this scam of a business.
That's if he's honest and if Angelides has the balls to ask the right question.
I'm not holding my breath on either count.