$23.54
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Moody's Corp (MCO)
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A provider of credit ratings, research & analysis covering fixed-income securities, other debt instruments & quantitative credit risk assessment products & services & credit processing software for banks, corporations & investors in credit-sensitive asset
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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.
http://caps.fool.com/Blogs/ViewPost.aspx?bpid=202202&t=01001019292467236494
Deej
Deej,
Understand your rage, but don't let your principles stop you from making money. If the ratings agencies are going to profit from cleaning up the mess they themselves allegedly helped to create, why not skim off some dollars for yourself...:-)?
quality post.
Quality post, I'm in the mortgage industry and I cringe every time I hear people complain about the evils of banking or the horrible lenders that wrote subprime/adjustable/negatively amortizing (insert favorite loan to hate). The issues that we are currently having are not with the term of the loans or with how they adjust, our woes stem from the fact that people completely misjudged the risk of these loans.
If lenders had priced loans 2% (or 8% or anything in between) higher in rate than a comparable conforming loan then there would have been less demand from consumers to take advantage of these risky loans (therefor a smaller volume underwritten) and more importantly lenders would have made enough of a larger profit spread to offset the default rates. The net result being that lenders never would have experienced the horrendous losses and lack of liquidity that we are seeing now.
That complete failure to judge risk extends especially to companies like moody's. So while I'm unsure that moody's is a bad investment, I agree with you in principle that it SHOULD be a bad investment and will be joining you in your thumbs down from principle.
"Why reform them if we can get rid of them? Are we waiting for them to blow up the Lunar economy as well?"
Excellent!
So let's see if I can sum up your pitch. Go short on Moody's, because it's a major player in a government-regulated oligopoly, and its products are required, by the law of the land, to be purchased and used by all parties to financial transactions?
I dunno about that. It's not exactly the most eloquent bear pitch I've ever heard.
You missed the point, ikkyu. The point is that there is a lot of pressure on the government to change the fact that the credit ratings agencies are a government-regulated oligopoly and that its products are required by law. If this changes, MCO will be much less profitable than it was in the past.
Deej
Well, I think you are saying that there is regulatory risk that isn't priced into MCO's stock price. That makes more sense. But I have to say I'm skeptical.
I hate Moody's probably as much as you do. Their corrupt and ridiculous practices were instrumental in getting us into this current mess. But, as much as I would love to see Moody's and Fitch and S P's rating arm pay for the trouble they've caused, I think there is probably also a real market for the services they were supposed to be providing - as opposed to what they were actually doing, which is rubberstamping 'AAA' on mountains of garbage securitized mortgage debt. For example, if all that subprime debt had been accurately rated with regard to its risk, we might not have the kind of trouble we are having right now.
I don't really see another player stepping up to take on that role. So I think a short-Moody's thesis, while morally attractive, might be a dangerous place to put your actual money.
Agreed ikkyu. I wouldn't short MCO with real money, but it's fun to short these #$%@&^ in CAPS. While we're on the subject, did you see that CAPLERs is suing them...at the exact same time that the government is considering making changes to the credit rating system. I hope that the folks at CALPERs hold their feet to the fire and dig up all sorts of dirt.
Deej
Deej,
Hmmm, did you also see though that part of the basis of CALPERs case is that they (CAPLERs) did not understand what they were investing over $1bn of their money in?! If I were the judge and they said that in court, I'd be mightily tempted to tell them it was their own stupid fault if they lost their investment. I find it hard to sympathise with them (though I feel sick for the people whose pension funds will suffer as a result). Much as I agree that the ratings agencies were flinging AAA ratings around with ridiculous abandon and deserve to be punished for so doing, I hope CALPERs loses the case. It reminds me of those stories you hear about people who've bought a house at auction without even viewing it, then complain that it's a dump...
Apparently Buffett agrees with Einhorn and myself as well. He recently sold recently sold 8 million shares of the company.
Deej
If MCO is not to be trusted, then what replaces them? It seems that at this point smart investors would have alternative means to judge the soundness of the investments normally scored by MCO. Do alternatives exist? Or have MCO and the others adapted and improved?