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Einhorn Joins Me in Shorting Moody's...Now That's What I'm Talking About



May 28, 2009 – Comments (7) | RELATED TICKERS: MCO

I hate the ratings agencies.  I have been short Moody's (MCO) in CAPS for a long time now, much to my detriment after the recent run up in its share price and I will remain short it out of principle until the day I die.

I got good and riled up about these shysters earlier today when I read the following outstanding article on them from Bloomberg: The Ratings Trap.

It absolutely blows my mind that the ratings agency oligopoly which wreaked havoc by creating $3.2 trillion dollars in subprime mortgage securities, (75% of which they assigned AAA ratings) and by failing to see problems at companies like Lehman Brothers (which was rated A+ by Fitch, A2 by Moody's, and A by S&P days before it filed for bankruptcy), Bear Stearns (which was rated A / A2 / A+ respectively two days before it was forced into a takeover by JPMorgan Chase), and AIG (which was rated A- / A2 / A two days before the government rescue) is now making money by helping the government clean up the mess that it created.  According to Connecticut's Attorney General Richard Blumenthal, the three could end up splitting as much as $400 million in taxpayer money during the cleanup process!  Are they serious?  Doesn't this bother anyone else?  How on Earth can this be allowed to happen? 

The existing ratings agency rules in the U.S. need to be changed and changed now.  State regulators use the ratings from these agencies to monitor the holdings of insurance companies.  The SEC (mwhahahaha, oh sorry about that) requires money market managers to rely on the absurd ratings from these companies to decide where to put the $3.9 trillion dollars in investor money that is in their funds.  Heck even the freaking Federal Reserve's relatively new TALF program, which essentially finances the purchase of up to $1 trillion in consumer loan and other asset-backed securities uses the ratings agencies grades to decide what can and cannot be purchased.  The same thing goes for the commercial paper that the Fed has been buying.

These companies get paid to rate bonds by the companies that are creating them.  Doesn't anyone else see the conflict of interest?  At the very least, we need some good old-fashioned punishment here.  If I was at the SEC, I would fine the living ship out of these companies and change the rules (like the one on Nationally Recognized Statistical Ratings Organizations) that make them a legal oligopoly to start. 

The three big boys in this industry, Moody's, S&P, & Fitch control 98% of the market for debt ratings!  Their government-mandated monopoly enables them to do whatever they want in terms of being wrong on their ratings and charging whatever they want to without any repercussions.  Moody's average pre-tax profit margin over the past several years has been over 50-freaking percent.  I'm all for profits and I am normally vehemently opposed to windfall profit taxes, but when the only reason a company can completely screw its customers is that it operates in a government mandated vacuum, something has to change.

I love the quote in the Bloomberg article by S&P's CEO on why these companies' profits are so high: "Why does anybody pay $200, or whatever, for Air Jordan shoes?  It's the same.  People see value in that.  And it all boils down to the value of what people see in it."

Ahhhhhh, no Mr. Sharma.  This is how it really works.  No one is paying you through the nose for your services because they see value in them.  The government is forcing them to buy "shoes" from an SEC-created cartel where only three companies are allowed to make "shoes" and that it doesn't really matter how crappy they are.  That's what is really happening here.

Enough of my rant.  Back to the purpose of this post.  David Einhorn of Greenlight Capital, who is known for shorting Lehman Brothers well before most other people and for his short of Allied Capital (which was described in the excellent book Fooling Some of the People All of the Time), disclosed today that his fund has a significant short position in Moody's.  I say good for him.  I hope that he makes millions in the process of exposing these thieves for what they really are and possibly instigating some change in the industry in the process.

Einhorn believes, and rightfully so, that investors have learned to ignore the ratings agencies' grades on debt.  Here's what he had to say about the company at the Ira Sohn Investment Research Conference today: 

If your product is a stamp of approval where your highest rating is a curse to those that receive it, and is shunned by those who are supposed to use it, you have problems.

The truth is that nobody I know buys or uses Moody's credit ratings because they believe in the brand...They use it because it is part of a government-created oligopoly and, often, because they are require to by law

On the possible reform of the ratings agencies he said:

Why reform them if we can get rid of them?  Are we waiting for them to blow up the Lunar economy as well?

Despite the massive hit that it has taken to its reputation and the destruction of one of the most profitable aspects of its business Moody's currently trades at a rich 19 times earnings.  Get this, Einhorn believes that Moody's has a negative net worth of $900 million.

Last year during this very same hedge fund conference, Einhorn recommended shorting Lehman.  That worked out pretty well for anyone who followed his advice.  These companies disgust me.  I was early to the short Moody's party, but I plan on staying until last call.


7 Comments – Post Your Own

#1) On May 28, 2009 at 4:36 PM, TMFDeej (97.48) wrote:

Another interesting idea was presented at the aforementioned Ira Sohn Investment Research Conference today.

This one was by Bill Ackman of Pershing Square Capital, who is known for his shorts of MBIA (MBI) and Ambac and more recently for his thus far unsuccessful battle with Target's (TGT) management.

He was bullish on General Growth Properties Inc. (GGWPQ.PK) despite its recent bankruptcy filing.

The stock soared nearly 38% after his presentation today.


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#2) On May 28, 2009 at 4:40 PM, outoffocus (22.84) wrote:

I agree. I've had a red thumb on Moody's since March. Anyone who can look at the US Gov's balance sheet and give it a AAA rating is shady in my book.

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#3) On May 28, 2009 at 5:08 PM, portefeuille (98.91) wrote:

The video of the talk (on ALD and stuff) that is on the page you linked to is interesting.

I am currently score leader for MCO (via 5 "outperform" calls). I still think rating agencies are stupid (or clever and not showing that in their "output" very well ... (or neither)).

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#4) On May 28, 2009 at 5:18 PM, leohaas (30.08) wrote:

I hit the Rec button after reading your first sentence. I agree with almost all of what you say here. However, I will not bet against an oligopoly, especially one that generates an "average pre-tax profit margin over the past several years (...)over 50-freaking percent". Only if the government changes the rules will we see these three go down.

My question: how would you change the rules? We still need some kind of rating system, don't we?

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#5) On May 28, 2009 at 5:26 PM, Seano67 (23.47) wrote:

Great post, Deej. And I couldn't agree more with that article. Ratings agencies have acheived far, far too great a degree of influence, and they are absolutely rife with potential conflicts of interest. But as leohaas said, how do you put a stop to that?


And RE: Bill Ackman and his battle with Target, that's a hell of a thing there. It will be fascinating to see how that vote turns out, and I'd give just about anything to be a fly on the wall in Waukesha, Wisconsin today. Ackman always brings fireworks to the game. He's an extremely interesting character. 



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#6) On May 28, 2009 at 6:52 PM, portefeuille (98.91) wrote:

from ftalphaville: 1

the speech: 2

the 2008 speech: 3 (pdf)

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#7) On May 28, 2009 at 8:32 PM, portefeuille (98.91) wrote:

here is something for the corporate debt fan in you:

auto finance company debt (see this video. see the whole video, it is great. the auto finance company debt part starts at 00:52:15).


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