Charlie Gasparino Takes Negative View on Warren Buffett’s Ratings Agency Testimony

Charlie Gasparino rips Warren Buffett for his stance on the ratings agencies and their role in creating the financial crisis. Here’s the money quote:

He believes that [rating credit is] a sleazy business and it makes a lot of money so he’s gonna own it. Well, that takes Warren Buffett down three notches in my book.

Take a look. Video embedded below.

Where I agree with Buffett is where he sees bad times ahead for municipalities and states and their bonds, something I have noted in the past (as have Jim Chanos, Fred Sheehan, Meredith Whitney and Rick Bookstaber in posts on CW):

“If the federal government will step in to help them, they’re “Triple A,” he said. “If the federal government won’t step in to help them, who knows what they are? If you are looking now at something where you could look back later on and say, these ratings were crazy, that would be the area.”

This will be a drag on recovery. However, I don’t agree that municipals are Triple A because of the implicit or explicit backstop of the Federal Government any more than I believed the same about Fannie and Freddie. If states and municipalities cannot stand on their own, they are not Triple A.  And their CDS spreads reflect this fact. This is exactly the problem with the credit crisis and the bailouts.  The ratings agencies are a big part of this problem. Claiming that an organization is triple A when it needs to be propped up by another level of government doesn’t make sense to me. I find it surprising that Buffett would make such a claim.

Update: to be clear of where I take issue with Buffet, let me add some more comments.  What Buffett is suggesting is that the Federal Government take select states and/or municipalities under its wing and socialize their losses. That is what he implies when he says "If the federal government won’t step in to help them, who knows what they are?" Given the context of the discussion i.e. Buffett having stated earlier that the government needed to bail out financial institutions in the same manner, it is pretty clear he is suggesting it may need to do the same here again with local government.

I am uncomfortable with this. Sure, if government backstops states or municipalities, they can get a AAA. I could receive a triple-A as well. What I have a problem with is giving an explicit or even implicit backstop to an organization which on its own is not triple A in the first place. This is exactly the problem we faced with Fannie and Freddie and we see what is occurring there – massive losses for taxpayers.

And the ratings agencies have facilitated this dilemma by giving ratings to governments that are not at all reflective of the longer-term un-backstopped fiscal position they face.  In my view, this is exactly what the sovereign debt crisis is about – it is about taxpayers and sovereign bondholders balking at the risk transfer from private agents to the sovereign in a way that weakens the sovereign. We see that in Europe and even between European states within the Eurozone. I do not want to see it here with states or municipalities.

Source

Buffett warns municipal debt next ratings minefield – National Post

12 Comments
  1. JustinS says

    Charlie Gasparino is down about 5 notches in my book, and he started at zero.

    How about auditors, how about stock analysts? do you take everything they say as gospel? no, of course not. if charlie read a bit of ben graham he might realise that everyone should do their own research and come to their own opinion – and be right or wrong based on their own analysis. if you are too lazy to do that and you blindly trust ratings agencies then you cannot blame anyone else other that yourself for things that happens as a result.

    buffett bought in when he observed high returns on capital and a maintainable competitive advantage / oligopoly amongst the ratings agencies. it was not that he particularly believed in the product.
    this is no different to the profit that big 4 audit firm partners make. Are they infallible, no. but no one else can do their job so they make large economic profits. welcome to capitalism Charlie, dont hate the player, hate the game.

    the economy did not end up as it is because of the ratings agencies, despite them most definitely playing a part. now they are scapegoats because it is EASIEST to point the blame at them.
    the economy is in its current mess because of widespread greed, belief in a free lunch and a massive inability to recognise the difference between price and value.

  2. Mtbomb says

    Regarding the AAA rating on cities:
    I think what Buffet is trying to say is that their true rating is (percentage chance the Feds guarantee the debt) x AAA + (percentage chance cities are on their own) x (rating based on financials).

    This just means the cities and states should trade a little better than a random company in the same financial position because of the chance of a bailout.

  3. guest says

    C’mon. When the Fed backs any entity, that entity becomes AAA.

    1. Edward Harrison says

      Obviously, I am not an idiot as we discussed offline. What Buffett is suggesting is that the Federal Government take select states and/or municipalities under its wing and socialize their losses. That is what he implies when he says “If the federal government won’t step in to help them, who knows what they are?” Given the context of the discussion ie Buffett having said earlier that the government needed to do the same with financial institutions, it is pretty clear he is suggesting it may need to do the same here again with local government.

      I know you are as uncomfortable with this as I am. Sure, if government backstops states or municipalities, they can get a AAA. I could receive a triple-A as well. What I have a problem with is giving an explicit or even implicit backstop to an organization which on its own is not triple A in the first place. This is exactly the problem we faced with Fannie and Freddie and we see what is occurring there – massive losses for taxpayers.

      In my view, this is exactly what the sovereign debt crisis is about – it is about taxpayers and sovereign bondholders balking at the risk transfer from private agents to the sovereign in a way that weakens the sovereign. We see that in Europe and even between European states within the Eurozone. i do not want to see it here with states or municipalities.

      I will add a comment to this effect to the original post.

  4. J. Powers says

    Yeah, if all US taxpayers (or their duly elected representatives) explicitly and en masse agree to backstop your debt, I can see how I’d lend you $20. And if it’s implicit, like me lending my nephew $20 expecting my brother to make good on it if my nephew chokes?

    Thinking about it, I suppose I’d say in that case that I was really lending money to my brother, since he’s on the hook for it. So, yes, any entity that receives an independent rating must be presumed to be able to undertake debt obligations on its own two feet. Otherwise the rating is a misrepresentation.

    1. Edward Harrison says

      J. Powers, that is my point exactly. Freddie Mac and Fannie Mae did not have any of the hallmarks of Triple-A financial institutions given their low capital base and the bust in housing. yet, the ratings agencies continued to rate them Triple-AAA. In the end, bond holders like the Chinese wanted to be made whole and they were. This set a bad precedent and the moral hazard that Buffett is supporting will end up shifting much of the risk that state governments and their bondholders should bear over to the Federal Government. Let’s see how this plays out.

  5. wmartin46 says

    The argument that Buffett makes seems to be that government entities have a right to operate with “moral hazard”—just like the private sector seems to have been doing–with the help of the US Government/Taxpayers. If that’s so .. then everyone has a right to “blow it out” and send the bill to Washington. How does that not doom the country?

    What Buffett, and his detractors, have not said is: “how big is this problem”?

    So .. how many dollars in Muni bonds are we talking about, and why do they need to be sold right now? Assuming that much of this money is for long-term capital projects, what’s the problem with deferring these bond sales/projects downstream for 3-5-10 years?

    In many cases, there are industry segments that are depending on this money (construction, hardware, design), all of whom are not officially on the government’s payroll, but might as well be when the dollars are dolled out. Is this why the Federal Government needs to backstop these bonds—to keep the real unemployment numbers down?

    And then there is the crazy use of bond money. In California, we are seeing some governments actually selling bonds to pay for post-retirement benefits. How insane is that? The use of these funds does nothing to enhance the livability, or desirability, of the jurisdiction selling the bonds, thereby increasing the tax base.

    So .. before I get to concerned about what Warren Buffett is saying .. I’d like to see a complete audit of those governments having “bond problems” to see if a more professional management team could negotiate these troubled waters with the money they have, and not gobs of other people’s money.

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