3 Jun 2010

Warren Buffett defends credit rating agencies

Buffett is Moody's largest shareholder

Billionaire investor Warren Buffett has defended credit rating agencies for failing to spot the US mortgage bubble that sparked the financial crisis.

Giving testimony in New York, Mr Buffett said the agencies "made the wrong call," but added that so did everyone else, including himself.

He said the US had been in "mass delusion" for not recognising that the housing market had overheated.

The agencies gave high ratings to US mortgage-related debt that went bad.

'Deeply disturbing'

Mr Buffett, the largest shareholder of the Moody's credit rating agency, was speaking before the US Congress's Financial Crisis Inquiry Commission (FCIC).

"The entire American public was caught up in a belief that housing prices could not fall dramatically"
Warren Buffett

This is investigating the role of the credit rating agencies in the financial crisis in the view to introducing tougher legislation.

The agencies have been accused of giving over-generous ratings to investment packages that included US mortgage debt that subsequently turned bad when homeowners defaulted on their payments.

The European Union is also proposing a new watchdog to oversee the agencies.

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

He added that if he had known how far the US housing market would collapse, he would have sold his investment firm's stake in Moody's, which currently stands at 13%.

Moody's chief executive Raymond McDaniel admitted to the commission that his company "is certainly not satisfied" with the performance of the ratings it gave the mortgage-linked debt.

He added that it was taking steps to improve its ratings process.

However, he had earlier said in written testimony that investors should only use credit ratings as a guide, "not a buy, sell or hold recommendation".

Conflict of interest?

Rating agencies such as Moody's, Standard & Poor's and Fitch Ratings have been criticised for conflicts of interest because their fees are paid by the banks whose deals they rate.

The Financial Crisis Inquiry Commission has already held four hearings

"Mr Buffett may seem and may be a genial upstanding figure, but he is also a big player in all kinds of financial businesses which played their part in trashing the US economy"
John Mervin, BBC World Business Report, New York
[see Rating agencies' role under scrutiny http://news.bbc.co.uk/2/hi/business/10207024.stm]

Billions of dollars of complex debts that were given the highest "AAA" rating by Moody's, Standard & Poor's and Fitch, went bad during the financial crisis.

FCIC chairman Phil Angelides said in his opening remarks that Moody's had profited greatly from rating mortgage-backed debts.

He noted that the firm's revenues soared from $600m (£412m) in 2000 to $2.2bn in 2007, just as the US housing market bubble had peaked.

Mr Angelides said that while the company profited, "the investors who relied on Moody's ratings didn't do very well."

The commission's vice chairman, Bill Thomas, said the aim of the inquiry was to determine whether the rating agencies were "a cause of the crisis or one of the victims".

Former Moody's managing director Jay Siegel admitted to the hearing that only 10% of the firm's employees had any direct experience working in the mortgage lending business.

Meanwhile, another former Moody's managing director, Gary Witt, criticised the role of hedge funds in the financial crisis, describing them as "wolves, hunting in packs, eating what they killed".

Mr Witt said that by contrast, the rating agencies were "scapegoats", whose primary function was "to absorb the blame for the sins of the community".

One investment fund, the Montana Board of Investments, said in written testimony to the FCIC that it would not have bought into the mortgage linked debt "without the over-inflated ratings published by the rating agencies".

"On the face of it, it seems preposterous for the rating agencies to have suggested that these complex, exotic creations were as risk-free as US government bonds," it said.

"But at the time, the board still had confidence in the rating agencies, and assumed the [investment] vehicles had been thoroughly vetted and that default risks were low."

New legislation

The Senate's draft of new financial services legislation proposes that the rating agencies should be chosen by an independent board of regulators.

It is hoped this would discourage rating agencies from providing overly-generous ratings in order to please the banks who pay them.

The Senate's proposal is, however, one of a number of differences with the House of Representatives' own version of the legislation.

These will need to be reconciled before the new law can be finalised.

Europe is also looking to reform regulation of credit rating agencies, with the European Commission announcing on Wednesday that it plans to create a new pan-European watchdog to control how they operate.

"In contrast to banks and insurance companies, rating services are not linked to particular territories"
EU Commissioner Michel Barnier
[see EU plans new financial regulator for rating agencies http://news.bbc.co.uk/2/hi/business/10215957.stm]

Under the proposals, banks would be forced to disclose full details on their financial transactions to all the rating agencies.

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