Einhorn vs. Buffett on Moody's

There's a Battle Royale in Moody's (MCO), it appears, after David Einhorn engages on the short side versus Warren Buffet's long position. For those not familiar with David Einhorn, he is a youngish hedge fund manager who exposed Lehman Brothers in a very public way. That said, his hedge fund lost 22% last year - but he's still a very bright mind, just from watching his TV appearances and reading some of his work. He has been a big buyer of gold of late [Mar 17, 2009: John Paulson Joins David Einhorn as Gold Bug] If you read one thing this week, please read this opinion piece Einhorn co-wrote with Michael Lewis [Jan 5, 2009: New York Times Opinion Piece by Lewis and Einhorn]

As any of us who have followed this financial disaster know, the credit agencies (who are being PAID by the people who have products they want rated - laughable) have been asleep at the wheel for years and a major complicit factor in this blowup. It appears Einhorn wants them gone... (emphasis mine; my comments in italics).

• David Einhorn, the hedge-fund manager who bet against Lehman Brothers Holdings Inc. four months before the firm collapsed, is shorting Moody’s Corp., whose flawed ratings on asset-backed debt helped fuel the credit crisis.
• “Even Moody’s largest shareholder, Warren Buffett, has said he doesn’t believe in using ratings,” Einhorn, 40, said in a speech last night at the Ira W. Sohn Investment Research Conference in New York. “We are short Moody’s.”
• Moody’s, whose founder created credit ratings in 1909, reported a 25 percent profit drop last month as the recession sapped demand for debt grades. Rating companies have been criticized by the European Union, members of the U.S. Congress and the U.S. Securities and Exchange Commission for ignoring conflicts of interest and risks that contributed to the worst financial crisis since the Great Depression.
• Einhorn, who runs New York-based Greenlight Capital Inc., said regulators could improve the stability of the financial markets by eliminating the formal rating system. He titled his speech “The Curse of the AAA.”
• Greenlight, which Einhorn started in 1996, manages about $5.1 billion in assets. The firm’s Greenlight Capital LP fund gained 4.4 percent in the first quarter, after losing 23 percent last year. Greenlight has returned an annual average of 20.8 percent from its Greenlight Capital LP fund since its inception.
• “The truth is that nobody I know buys or uses Moody’s credit ratings because they believe in the brand,” Einhorn said. “They use it because it’s part of a government-created oligopoly and often because they are required to by law.” (I love when truth is spoken)
• “If your product is a stamp of approval where your highest rating is a curse to those that receive it and it’s shunned by most who are supposed to use it, you have problems,” he said.
• Buffett, the chairman and chief executive officer of Berkshire Hathaway Inc., said earlier this month that assigning ratings to debt and other securities “is still a good business.” Berkshire owns about 20 percent of Moody’s shares. Still, Buffett said he doesn’t rely on the major credit rating companies to make his own investment decisions.
• “We do not think the people of Moody’s, Standard & Poor’s, Fitch or anyplace else should be telling us the credit rating of a company,” Buffett said May 2 when Berkshire had its annual meeting in Omaha, Nebraska. “We don’t believe in outsourcing investment decisions.”

Buffet owns it because, as

Einhorn

says, the government has decreed 3 companies should have all the power in assessing credit risk. Even though much smaller competitors like Egan Jones who are not part of the oligarchy nailed things. Frankly in this case Buffet is coming off a bit two-faced... he has an investment here because he knows it has a wide, government protected moat - but he does not use the conclusions from his investment for his own decisions. That pretty much sums up the usefulness of these major credit agencies. Remember AIG (AIG)? One of a handful of AAA rated companies this decade. Bought and paid for...

What's that? Oh yes, the USA is a free market capitalist system where competition is supported and large political donors don't get government protection. Yep.

More from

Reuters here

• Einhorn contends that investors have learned not to rely on Moody's, which for years has been criticized because it earns fees from the companies it rates. And after the mortgage market melted down in 2007, Moody's came under fire for giving top grades to bonds and derivatives backed by subprime loans.
• Einhorn noted equity investors still believe in the agencies. Moody's shares trade at 19 times estimated earnings, he said, though he said the company has a negative net worth of $900 million.
• Moody's had long been a favorite among investors because the limited number of firms approved by the U.S. government to rate debt lets these firms generate fat profit margins. McGraw-Hill Cos Inc's (MHP) Standard & Poor's and Fitch Ratings are Moody's rivals.
• "Why reform them if we can get rid of them?" he said. "Are we waiting for then to blow up the Lunar economy as well?" (But David, they contribute so much to certain politicians - we really need to keep them.)

Must be nice to push a stock down 7% just with the power of 1 speech - that's "Street" Cred.

Disclosure: No position

Comments

[JPPennypacker:]

If much smaller competitors such as Egan Jones "nailed things" then maybe they will be gaining market share as some of the larger ratings agencies appear to have some issues to work out. As litigious as many of these paper pushing businesses are I am surprised that they have not fallen over themselves to clog the courts with ratings agency lawsuits. I guess the AAA rating must not carry much of a guarantee and the big rating companies must be somewhat lawsuit resistant to date.

May 29 01:42 AM

[Tom Armistead:]

Moody's is an easy target: bashing them has been popular for a year or more. No doubt Einhorn will make money on his trade.

CDS spreads, which are frequently used as an alternative and more effective measure of credit risk, are unfortunately generated in an opaque and unregulated market, and are subject to fraud, manipulation and abuse. Major players are resisting change in theis area, not a promising development.

Constructive approaches to the problem Einhorn is dramatizing for his own profit would entail 1)removing legal requirements that limit some investors to securities highly rated by NRSROs, 2) removing rating based "triggers" from contracts which impose increased collateral requirments in the even of a downgrade, 3) imposing standards of due diligence on the NRSROs, with legal accountability for lapses, and 4) cleaning up the CDS market, making it transparent and severely reducing fraud, abuse and manipulation.

May 29 07:40 AM

[BSexposer:]

Einhorn has botched this one - govt is not going to remove the "oligopoly" status anytime soon - and even if they do, Moody's will survive and continue to make good money. Let's be honest - is Egan Jones really going to replace Moody's and S&P? I think not. Go with Buffett here, not Einhorn (although Einhorn is usually on the mark).

May 29 10:36 AM

[RiskReturnO...:]

Both Einhorn and Buffett can be right in this investment. It's just a matter of timeframes and valuation.

Einhorn think the PE of 20 is not justified, so perhaps it should trade more in line with the SPY @ around 15x. So he stand to profit 25% if the stock just moves back to market valuation.

Buffett's bet is very long term, and he entered at much lower prices, so he's still enjoying quite a profit.

May 29 12:03 PM

[RogerScott:]

Buffett's non use of ratings is not relevant. He would not depend on any outsider even if they were excellent. He has the skills to do his own analysis which is going to be the same or better than the best analyst for any business in his circle of competence. If Einhorn made a big deal about Buffett, he misunderstands him or perhaps he is abusing his name.

May 29 01:25 PM

[Gtarras:]

If Einhorn thinks that all internal and international regulatory requirements for banks, pension, and other funds (pretty much whole financial system) should be easily brushed aside and can be done, then good luck to him.

Like Tom in the above comment said, the NSRSOs are an easy target. They do serve an important purpose though, as a regulatory glue. Just like democracy, the system sucks, but thats the best we got. A lot of arbitraging of ratings is going on. But thats what makes the system complete, by filling in the cracks.

Of course nobody on the street in their right mind would rely on the CRAs. At the same time, people on the street realize that they serve some other purpose. Like I said earlier, they lay out the foundation. All other managers out there fill in the cracks. It will not change.

Einhorn is simply talking his book. Similar to Ackman. Cant stand those guys personally, because they are the two-faced sharks really, but they are what makes the system complete.

May 29 02:23 PM

[bcncv:]

You're combining answers to two different questions.

Einhorn is referring to whether Moody's ratings may have a bias, and the excessive level of trust that people give to ratings.

Buffet is dealing with Moody's as a business to invest in because of the industry barriers to entry and the increasing importance (even if misplaced) of ratings.

Both of them are right.

May 29 07:38 PM

[Jasper M:]

"I love when truth is spoken" Amen, Mark, amen.

I shorted Moody back in 2006, for one of the reasons cired - it gets its business due to government imposition. I find it pleasant, and profitable, to bet against that sort of thing. Been very happy with that choice.

BSex, at some point, backlash will generate lawsuits alleging liability for untold losses, and some of them will be one. That will open up unTold liability exposure.
(Ironic - a company that failed to properly measure exposure to risk will e presented with hard to measure risk)

Gtarras, the difficulty of "brushing aside" you mention, the 'inertia' of the system, if you will, is proportional to total 'mass' ($?) involved. As the unprecedented bloating of the financial industry reverses, there will be less and less for external forces (= outrage) to push around.

bcvnvc, I don't see barriers to entry being a save for a furiously declining business base. It's like being rewarded with a near exclusive contract to manufacture buggy-whips - sure, we'll need a Few . . .

May 29 08:11 PM

[Madrid:]

I look at the chart of MCO and all I see is a screaming buy, with upside potential of doubling and tripling. Einhorn is simply wrong-- ratings agencies are going to become even more important as a result of all this mess, and companies like Wells and JPM are going to hold up their AAA rating as a huge bage of honor, a sign that they weathered the storm and could weather another one.

I bet Buffett wishes he could double his stake in MCO.

May 29 10:20 PM

[John Galt:]

I still remember last fall when the Wall Street Journal has a big article about the battle between Einhorn and the attractive female at Lehman Brothers.

She said Lehman was well capitalized, Einhorn predicted catastrophic results and had a huge short position. Winner: Einhorn.

It seemed like Einhorn was an analytical kind of guy that dug deeply through the company's information, read the 10k,s 10qs, understood their products, what they did and the implications while SHE was touting the company line. Dick Fold held that company line until the company went belly up and some guy punched his face out at the gym.

Good point about how Buffet wouldn't even trust the ratings agencies.... So what's their point? How do they bring value to our economy?

May 30 05:41 PM

[plang1:]

what is the connection between einhart and geitner? someone at a high government level is feeding him information on upcoming policy changes that will affect the major credit ratings agencys. this leak of insider information must be checked into and closed...

Jun 16 01:56 PM