Billionaire investor Warren Buffett will testify today before the Financial Crisis Inquiry Commission on how credit-rating agencies influenced the financial crisis. Buffett's Berkshire Hathaway owns a 13 percent stake in Moody's, one of the three biggest agencies and one that's been a heavy target of the FCIC.
The financial reform bill in Congress is taking a deeper look at the business models of these ratings agencies in hopes of fixing them. Ratings companies have come under fire for labelling risky investments as triple-A, falsely pegging them as a safe bet and driving investors to flood the market with bad deals. Agencies were protected by the government from competition and ratings were considered free speech, which shielded them from law suits.
Critics say that in the period leading up to the financial crisis, the agencies downplayed risk, causing inflation on Wall Street. When they finally decided to downgrade, they did it way too fast. Another major concern is that credit ratings agencies have a huge conflict of interest, as companies pay the agencies to rate them.
Kevin LaCroix, partner at Oakridge Insurance Services, says that "in effect, the government is requiring certain investors to only buy investments that have been rated by these rating agencies that are approved by the government."
Moody's CEO Raymond McDaniel, who is testifying alongside Buffett, says the agency is working to improve its ratings process, but that investors shouldn't rely on ratings to buy or sell securities. McDaniel says inaccurate ratings of mortgage-related investments have been "deeply disappointing" to the company. Moody earns about two-thirds of its income from ratings.
Buffett is generally not opposed to being in the public eye, but he reportedly resisted attending the commission inquiry until he received a subpoena, according to the San Francisco Chronicle.
LaCroix notes Buffett has made a lot of money off of Moody's from buying company stock in 2000 that has appreciated significantly in value. "But he's also been a commentator on the financial marketplace, and has even said some colorful things that raised a question whether while he was profiting on Moody's, perhaps he was overlooking what some of the ratings agencies were doing at the time."
Inquiry could affect ratings agency pay
Mike Konczal, a fellow at the Roosevelt Institute who follows financial reform, is critical of previous methods utilized by the ratings agencies. "It's like if the government said agencies of government had to use Amazon to decide what textbooks to use." He says the legislation before Congress would have the government assign agencies to rate corporate debt and strip the agencies of their protections. "Taking that out of the law will then let private agents kind of determine whether or not there's value in them."
But Robert Litan at the Brookings Institution says the bills won't be able to fix the viewpoint of rating agency employees, who feel they should be working "at the equivalent of Goldman Sachs or Morgan Stanley." Analysts at the agencies still may want to keep banks happy in order to swing a better-paying job, but Litan says after this crisis, working at a ratings agency could mean a resume downgrade. "As Rodney Dangerfield would say, they don't get respect and I'm not sure it's going to be possible for them to earn their respect back."
With that respect gone, Litan says many investment funds have simply stopped paying attention to the rating agencies and are doing the same work in-house.