David Einhorn, President, Greenlight Capital, elaborately discusses Moody's and McGraw Hill (owners of S&P), pointing out that their brands are ruined, centralized credit ratings are flawed and unreliable, and that market spreads are a much more reliable measure of risk than ratings. He praises Buffett for identifying Moody's as a great business 11 or 12 years ago, but goes on to identify the fact that the ratings are more often used to identify misrated securities. How ironic! A must-read interview given the times.
Perhaps the agencies should be re-named the Debt Misrating Agencies.
(This is not a legal transcript. Bloomberg LP cannot guarantee its accuracy.)
David Einhorn, President, Greenlight Capital, talks to Betty Liu about Credit Ratings agencies.
JUNE 3, 2010
SPEAKERS: David Einhorn, President, Greenlight Capital, Betty Liu, host "In The Loop",
BLOOMBERG NEWS
09:04
Betty Liu, Host "IN THE LOOP", BLOOMBERG NEWS: Hedge fund manager David Einhorn is an outspoken critic of the credit rating agencies. In a recent "New York Times" op-ed, he wrote, "One obvious lesson from the economic crisis is that we should get rid of the official credit ratings that inspire false confidence, aggravating slowdowns and inflating booms." Einhorn is the president of Greenlight Capital, joining us now on the phone.
David, great to have you with us.
David Einhorn, President, Greenlight Capital: Great to be here. Good morning.
Liu: Good morning. And I know you were watching the testimonies yesterday with great interest. You said that they were damning. What was most damning about this?
Einhorn: I think there's two basic issues that are kind of confused. One is there's a basic unchallenged view that the ratings are a public good. In fact, I think that the ratings are a public bad.
It's very risky to have your business or your - dependent on a single customer. Like if you sell all your product to Wal-Mart. And it's similarly dangerous to have your credit determined by one or two centralized official committees.
When you run into trouble, it's much, much better to be able to go to the entire market to prove your creditworthiness, and to try to borrow money as you need to. And so having this centralized decision-making is really a very big problem.
Liu: And yet, David, there appear to be this belief among Buffett and others that there really is no alternative to the current system. Is there really an alternative?
Einhorn: But it reminds me a lot like when my parents told me when we were seven that we were moving to Wisconsin. And I didn't know what would happen. Would I make new friends, would I have a new school? How would this all work out?
And I was very upset at the time. But we moved, and it kind of worked out okay. The idea that if we didn't have ratings, something - official ratings - something bad would happen, I don't think makes that much sense.
It's not like Morgan Stanley and Bank of America are going to say we can't underwrite bonds anymore. And it's not like bond buyers that say we can't buy bonds anymore. Basically we would just have a new way of going about it.
Right now, we do IPOs for stocks. There's no official ratings for the stocks before the IPOs get done. The market would adjust if we didn't have official ratings.
Liu: Well, in your best view - and I like your example of striking out on your own - if some companies or issuers were to strike out on their own, what would they find, though, David?
Einhorn: Well, right now we still have the system of official ratings. So they're sort of locked into it because everybody does it.
So what we really need is a systemic change to just reject the idea of having centralized official ratings. And then the market would adjust, and it would be the same adjustment for everybody. So nobody would have to be striking out on their own.
Liu: Okay, getting back to Buffett, though, David, were you surprised by his reasonings for backing Moody's?
Einhorn: Well, I think it's really very much to his credit. When he identified Moody's a decade ago, look at the competitive position that the company had. And I think he made a fine investment. It did well for a long time. Even with everything that they've done to ruin their brand, I think he still made a very nice investment for himself.
I think from here the risk reward in the stock is still pretty negative. And so we're on the other side. But I do understand what his thinking was.
Liu: But how much - and I know that you yourself - you've made a pretty nice investment so far in shorting Moody's, and also McGraw-Hill, which owns the S&P. How much further do you think those stocks have to go down?
Einhorn: Well, I think that they're lousy investments for a few reasons. I think first of all, that their brands are ruined. And yes, one thing that came clear in the hearing was that they basically had the attitude that our market position is so bad that no matter how poorly we perform and how badly we behave, that our market position will be preserved.
But I don't really think that that's true. I think that the brands are ruined. I think that Congress is already putting in laws that will make it much harder for them to recover towards their former level of profitability.
I think just yesterday Europe announced that they're going to regulate the rating agencies, basically with the view, I think, to getting rid of the U.S. credit rating oligopoly, at least reflecting European credit.
But ultimately these guys face enormous legal liability through a whole variety of lawsuits where if they ultimately lose even a single one and have to pay off any bondholders, given their capital structure - particularly Moody's, which has a fair amount of debt - they probably - equity holders won't do very well.
Liu: And, David, did you find that - I was going to ask you about that European model. But did you find, though, that what the Moody's executives and former executives were saying was going on at the company, did you find that that also is happening at Fitch and at S&P? This whole idea of understaffing and the pricing problems?
Einhorn: Right, well, when you look at the margins that their credit ratings had during the boom, it was pretty clear that they were charging a lot of money and not doing very much work. And there's a lot of evidence that these guys were very focused on their market share, and they allowed their quest for market share for profits to compromise their ratings objectivity. And that's what, for example, some of the legal challenges are about.
