Berkshire Hathaway Holds Steady with Moody’s

Each quarter investors anxiously await Berkshire Hathaway’s 13F filing to see how Warren Buffett has adjusted his portfolio during the last three-month period. His transactions are treated by some as harbingers of what is to happen in the upcoming months.

The general reaction to the most recent filing was that Mr. Buffett is adapting a more conservative mindset. Notable among the transactions, however, was that the position that Berkshire Hathaway held in the rating agency Moody’s did not change. In past periods, Berkshire Hathaway and Warren Buffett were aggressive in cutting their investment in Moody’s.

No reason was provide for this change in investment strategy; however, some are speculating that Berkshire Hathaway has renewed confidence in this rating agency and possibly the entire rating agency segment. This is logical, since Dodd-Frank punted on rating agency reform.

A New Business Model Emerging for Ratings Agencies

The credit rating agency Realpoint is considering whether to begin offering unsolicited ratings. Their intention is to sell ratings and analysis on a fee basis to investors.

Daniel Indivigilo of The Atlantic believes that serious issues need to be resolved. First is whether investors will have an appetite for unsolicited ratings. Fund managers are supposed to be the expert. Hiring an outside agency could make them look bad.

Second, Mr. Indivigilo writes, the rating agencies, Realpoint included, have trouble keeping their best analysts. They are quickly lured away by investment banks and hedge funds that can offer better compensation. To pay these talented employees, a competitive wage may cause fees for unsolicited ratings to be unfeasible if the volume doesn’t materialize, particularly in situations where the issuer is offering his or her own assessment at no cost.

Mr. Indivigilo concludes by saying that in theory unsolicited ratings are “a great thing to provide more perspective on the market and various securities,” but he cautions that “a bumpy road lies ahead.” This is how it is supposed to work. Let’s let the capital markets figure out the best architecture for rating investments. Government-imposed structure won’t be optimal.

Rating Agencies Threat to U.S. Economy?

Joshua M. Brown, a money manager for high net worth clients, charitable foundations, corporations and retirement plans, complained recently in a blog post for The Christian Science Monitor that rating agencies are threatening the still-fragile asset-backed securities market.

Moody’s Investment Services, Standard & Poor’s and Fitch Ratings, in reaction to the recently-passed Dodd-Frank law that overhauled U.S. financial regulation, would not allow their ratings to appear in bond registration statements. As a result, they effectively shut down the market selling new bundles of auto and consumer loans. The Security and Exchange Commission has since stepped in to untangle the situation.

Nonetheless, Mr. Brown accuses the agencies of cowardly and infantile behavior. He challenges that because the Federal Government would no longer shield the agencies from exposure to liability for their ratings “…they [the rating agencies] are taking their marbles and going home.”

This is a cheap ad hominem attack by Mr. Brown. Unlimited liability would equal a rating premium equal to the par amount of the bonds. The rating agencies acted rationally.

Bank Regulators Want Less Reliance on Rating Agencies

Bank regulators are currently drafting rules that would require banks to prove they had done adequate research before they could receive the regulatory capital benefits of holding highly rated bonds from securitizations. Regardless of how its holdings were rated, a regulated institution that depended exclusively on ratings for evaluating an investment’s safety would have to hold loss reserves against the full value of its position.

“If you can’t use a rating because you don’t want to get all the information, then presumably you won’t buy the instrument,” said a source close to the Federal Deposit Insurance Corporation, according to American Banker.

Certain legislators support the even more drastic approach of stripping “nationally recognized statistical rating organizations” such as Moody’s Corporation, Fitch Inc. and Standard & Poor’s of any official recognition in regulatory capital requirements. This is a positive sign. D.C. can’t say ratings are worthless and the process is corrupt, and then base capital ratings on NRSRO ratings. Let’s move away from the exclusive use of ratings.

Franken Amendment Dropped

House and Senate negotiators voted to drop Senator Al Franken’s (D-MN) proposal to eliminate conflict of interest from the way credit rating agencies are engaged. Franken’s amendment was initially adopted by a vote of 64 to 35.

The reasons were not ideological so much as they concerned implementation issues. Some of the chief sponsors of the bill, including Financial Services Committee chairman Barney Frank (D-MA) and Banking Committee chairman Christopher Dodd (D-CT) came out against the provision, warning of practical difficulties in making random assignments of rating agencies.

“Wall Street’s broken credit rating system played an enormous part in our economic meltdown, and it’s our duty as lawmakers to make sure that never happens again,” said Franken. “We know that conflicts of interest rewarded cozy relationships instead of accuracy, and we know how to fix the problem. The language agreed on by the conference committee means more time and more study than I think is necessary, but it also means definite action will be taken.” This stupid idea died. Good riddance.

Former Ratings Officials Testify Before FCIC

Eric Kolchinsky, Moody’s former managing director in charge of rating subprime mortgage securities, testified before the Financial Crisis Inquiry Commission. He told of how superiors pressured analysts to increase market share. He said that bankers seeking reviews for their mortgage securities took advantage of this by giving rating agencies no time to conduct proper reviews of the securities.

“That was the problem,” said Mr. Kolchinsky. “I said I needed three or four weeks to research the deal, but because bankers knew we could not walk away from a deal, they sent the documents three or four days before closing or even after closing.”

FCIC Chairman Phil Angelides, former state treasurer of California, remarked that, “The very system didn’t allow you to say no to a whole market slice.” Moody’s could have said no. They chose to rate. This is corporate responsibility, not ratings shortfalls.

Jules Kroll Launches New Rating Agency

Renowned corporate investigator Jules Kroll has formed his own credit rating agency, Kroll Bond Ratings.

“I see this as another version of due diligence. You really need to look at what the facts are, and then you rate them, which is what we’ve done for years but in a different context.” Kroll told National Public Radio.

Kroll says his new firm will apply the same principles of due diligence he employed in building his international financial investigative agency. He plans on going beyond simple mathematical models to look more closely at the properties and mortgages in question, for example, something he says the major rating agencies failed to do. “There’s been virtually no skepticism, no fact-finding. (By current ratings agencies.) It’s been the acceptance of what’s been presented by people seeking to raise money.”

The company is set to release its first ratings in July.

Let’s hear it for Kroll! The market is solving its own problems with ratings. If Kroll is better, everyone will use them.

Amendment to Add Create Rating Board Passes

The Senate has approved an amendment to its financial regulatory reform bill that authorizes the Securities and Exchange Commission to create a new credit rating board that would assign a credit rating agency to companies seeking an “initial rating.”

The proposal would only affect “structured securities,” which are mortgage-backed bonds, asset-backed securities, and other debt-like instruments that declined in value during the financial crisis.

Standard & Poor’s spokesperson Edward Sweeney criticized the amendment for the deleterious effect he said it would have on credit rating agencies’ “incentive to compete with one another, pursue innovation, and improve their models, criteria, and methodologies.”

The provision, proposed by Senator Al Franken (D-MN), passed by 64 to 35, which means it is likely to remain part of the final bill.

Financial expert, market technician and capital market participant Al Franken solves the conflict issue. This is a stupid idea. Is there ever a problem that can’t be solved by “more government”?

CalPERS Lawsuit Gets the Green Light

The California Public Employees’ Retirement System (CalPERS), the largest U.S. public pension fund, has won a court ruling allowing it to proceed with a lawsuit against the three main credit rating agencies for assigning “wildly inaccurate and unreasonably high” ratings. The ratings in question were regarding the AAA rating of three structured investment vehicles (SIV) in 2006 that allegedly caused the pension fund $1 billion in losses.

CalPERS is accusing the rating agencies of “negligent misrepresentations to CalPERS and CalPERS’ money manager agents, which have caused and will cause CalPERS to suffer substantial investment losses” by overvaluing the SIVs.

CalPERS claims that the agencies were the “only entities” outside those managing the SIVs who knew what assets were held by the opaque structures.

This is hilarious! CalPERS, a huge expert pension fund, was duped by too high of a rating? The California Treasurer complains the muni ratings of the NRSROs were too low!! This all looks like blame shifting.

France Blames Ratings Agencies for Aggravating Greek Credit Woes

Rating agencies have successively downgraded the sovereign debt of Portugal, Greece and Spain and this has, in part, led to a sharp devaluing of the euro. The European Union has protested that the lower ratings assigned to Greece, in particular, ignore the fundamental indicators of the Greek economy as well as the aid plan created by the euro zone and the International Monetary Fund.

When speaking on French radio Europe 1, French Economy Minister Christine Lagrade said that France will reinforce control over the rating agencies. “I think certain rules should be fixed … because we don’t degrade a country under the conditions that its rating has been degraded, that’s to precipitate purchases of sales 15 minutes before the close of trading, deplorable for the solidity of the market,” she explained.

In an interview with Le Monde, she also said that the downgrade 15 minutes before markets closed was “crime inducing” because it created a panic among those holding Greek bonds who thoughtlessly offloaded the investments before markets closed, driving values down even further.

Previous European Commissioner for Internal Market Regulation Michel Barnier expressed the opinion that rating agencies should be “disciplined and responsible in their evaluation process.” Mr. Barnier, also of France, had also mentioned that the European Union was considering creating Europe’s own rating agency to balance the valuation opinions of the American agencies.

Vive la France! This is like blaming the thermometer for the heat.

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