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Buffett Contradicts Himself

|Includes: Moody's Corporation (MCO), SPGI

Of the different players contributing to the 2008 financial crisis, many would place the credit rating agencies at the top of the list.  So why does Warren Buffett defend Moody's and its CEO, Raymond McDaniel?

The simple answer may be to protect his investment. Berkshire Hathaway controls 13% of the company.  His recent testimony before the Financial Crisis Inquiry Commission in New York, however, suggests a more problematic mindset, and points to striking contradictions in his otherwise logical thought process.

The latest article in the Lyceum newsletter Perspectives considers Mr. Buffett's disappointing testimony. Read here.

1. As Mr. Buffett indicates, he does not personally rely on credit ratings, but his ability to pick mispriced stocks does depend on everyone else relying on them.  Does his own fortune, then, excuse the agencies for being wrong?

2. Raymond McDaniel was just one more "among many who missed warning signs of the crisis”.  It would be unfair to single him out for blame. Okay, if that's the case, then we should blame no one, and completely dismiss the notion of 'risk'.

3. “I’m not arguing that this is a perfect model [the rating agency model, paid for by the issuers]. It’s very difficult to think of an alternative where the user pays." Hmm, what about the analysts Mr. Buffett pays for research? Isn't this an alternative?

4. 90% of Moody's 2007 investment grade ratings became junk twelve months later. Still Mr. Buffett does not view McDaniel and his firm as erring.

At issue here, as with financial reform itself, is the question of risk and return.  If lawmakers and regulators continue to shield certain individuals and institutions from risk, then they force all of us pay a social tax in higher risk premiums, to compensate for inappropriate risk-taking.

And the more the shield is extended, the greater the cost we bear in market inefficiency.

Disclosure: "No positions"