Don't get me started on credit rating agencies. Loved what Buffett said on incentives and how CEOs and Boards of financial institutions have to feel significant pain when their firms fail and the government has to bail them out, but the Oracle of Omaha didn't convince me that the current model for credit rating agencies is the best we can do.
The big three credit ratings agencies were threatened yesterday with fines and the creation of a new state-backed competitor, only weeks after European leaders attacked them for exacerbating Greece’s problems with downgrades.
The agencies will be subject to a new European supervisory body with the power to hand out fines and suspensions under plans unveiled in Brussels.
Work on a rival centralised European credit agency is also being carried out by the European Commission, José Manuel Barroso, its President, said.
The Commission’s plans were welcomed by Liberal MEPs but dismissed as heavy-handed by Conservatives, including John Redwood, who called on the bureaucrats to think again.
Mr Barroso, launching the plans yesterday, argued that the big three rating agencies — Moody’s, Standard & Poor’s and Fitch Ratings — should have done more to alert investors to the imminent demise of Lehman Brothers in 2008. “Is it normal to have only three relevant actors in such a sensitive issue where there is a great probability of conflict of interest?” he asked. “Is it normal that all of them come from the same country? Is it normal that such important entities are escaping fundamental regulation?”
Rating agencies have also come under fire in recent weeks after their downgrades of Greek and Spanish sovereign debt rocked markets and led the euro to slide against the dollar. Last month, Angela Merkel, the German Chancellor, and President Sarkozy of France demanded a review of their operations. But Mr Barroso insisted that plans for supervision and regulation were hatched long before the latest row.
Bond investors privately have cast doubt on the credibility of any new body rating sovereign debt if it is bankrolled by those same sovereign nations.
Martin Winn, a spokesman for S&P, said: “We welcome any and all competition, but ultimately investors and the market will determine which ratings are credible and useful.”
The European Commission proposed that an already-planned central European Union regulatory body — the European Security Markets Authority — should take on oversight of the existing rating agencies when it is due to begin work in January 2011.
The new authority would register rating agencies in return for a fee and check that they meet EU rules showing careful research of their rating and no conflict of interest.
The authority will be able to fine individual national offices of rating agencies that cannot or will not justify their methodology, or stop them from issuing ratings temporarily, or even permanently in the worst cases.
The proposal will now go to EU governments and the European Parliament for approval.
Mr Redwood called on the Commission to think again on its plans for supervision and a central European ratings agency. “They are going to find it extremely hard to change the way that credit rating agencies perform ... There is not a foolproof system for saying that certain assets are absolutely guaranteed in all conditions.”
Kay Swinburne, a Conservative MEP, said: “The problems in the eurozone are predominantly as a result of poor fiscal policies of some EU governments, not because of the decisions of ratings agencies to downgrade them.”
Buffett defends Moody’s
Warren Buffett has defended Moody’s, the ratings agency in which he holds a 17 per cent stake, for failing to predict the financial crisis.
Speaking at a hearing yesterday into why the agency had assigned top credit ratings to rotten mortgage products, the billionaire investor said: “They made a mistake that virtually everyone in the country made.” He described rising prices as a “narcotic that affects the reasoning power up and down the line”.
Critics complain that the agencies’ “issuer-pays” business model leads to conflicts of interest, but Mr Buffett said that, as an investor, he would not support a user-pays model, either.
Mr Buffett was forced by subpoena to testify at the Financial Crisis Inquiry Commission hearing in New York, having previously declined an invitation.
The commission also heard from former Moody’s analysts, who alleged that they were forced by their bosses to churn out ratings more quickly than they could properly analyse products, in order to increase the company’s share of the ratings market.However, Raymond McDaniel, Moody’s chief executive, insisted that an internal investigation had found no substance to the former employees’ claims.
Below, David Einhorn, chairman of Greenlight Capital Inc., talks with Bloomberg's Betty Liu about the outlook for credit-rating companies following yesterday's Financial Crisis Inquiry Commission hearing about the industry's role in the financial crisis.
I don't agree with all of Mr. Einhorn's positions, but on this one, he's 100% correct. Let's move past the nonsense of credit rating agencies and realize that the current model is fraught full of conflicts of interest. By allowing this nonsense to continue, we're making a mockery of our financial system and perpetuating the myth that these rating agencies are truly independent entities that have investors' best interests in mind. Nothing can be further from the truth.