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basl1
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Does anyone care to speculate where Buffett is going with this. Is he planning on selling all shares or simply getting down to a smaller number?

 

While Berkshire has trimmed positions in the past in order to maintain a basic level of liquidity, it seems like he's sold enough at this point that this is a pull-out.

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The business model has been broken for Moody's; their moat was based on trust and credibility to demand outsized margins in a market where a few suppliers could be trusted enough to evaluate and grade securities traded in the aftermarket.  This isn't the Salad Oil scandal -- http://en.wikipedia.org/wiki/Salad_oil_scandal.  When American Express lost money in that swindle, the biz model was still intact and in 1963 the Buffett Partnership put 40% of its assets into that fat pitch.

 

The bet on Moody's has changed and a permanent capital loss has been incurred.  Ergo, don't lose more capital and salvage what you can -- see Rule#1 in investing.

 

-O

 

Does anyone care to speculate where Buffett is going with this. Is he planning on selling all shares or simply getting down to a smaller number?

 

While Berkshire has trimmed positions in the past in order to maintain a basic level of liquidity, it seems like he's sold enough at this point that this is a pull-out.

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The business model has been broken for Moody's; their moat was based on trust and credibility to demand outsized margins in a market where a few suppliers could be trusted enough to evaluate and grade securities traded in the aftermarket.  This isn't the Salad Oil scandal -- http://en.wikipedia.org/wiki/Salad_oil_scandal.  When American Express lost money in that swindle, the biz model was still intact and in 1963 the Buffett Partnership put 40% of its assets into that fat pitch.

 

The bet on Moody's has changed and a permanent capital loss has been incurred.  Ergo, don't lose more capital and salvage what you can -- see Rule#1 in investing.

 

-O

 

Does anyone care to speculate where Buffett is going with this. Is he planning on selling all shares or simply getting down to a smaller number?

 

While Berkshire has trimmed positions in the past in order to maintain a basic level of liquidity, it seems like he's sold enough at this point that this is a pull-out.

 

 

I don't think that the moat relied upon trust and reliability. Moody's, S&P, and Fitch provided communication assistance; users could attach a rating to a security as a shorthand for relative performance. I don't think you will find many pension fund managers who actually believed that the ratings agencies provided thorough due diligence.

 

It's kind of like the FICO score. No one in finance thinks it replaces analysis, but it provides a standardized shorthand for less rigorously formed notions of quality. A bull market can stimulate activity to the point that the users only use the shorthand because they drank the kool-aid or they planned on passing the buck.

 

I'm curious to see what will happen with the ratings system. Moody's might not survive, but it doesn't mean that it's replacement will be any better.

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I'm curious to see what will happen with the ratings system. Moody's might not survive, but it doesn't mean that it's replacement will be any better.

 

This seems like a key insight, fwiw.  If (and when) the ratings agencies downgrade a company, their decisions often close off the ability of an entity to raise additional capital.  They are then often accused of causing the downfall their ratings were supposed to predict.  They seem to be in a permanent Catch-22 situation with this issue.  Thus, I don't see how replacement entities would be any better as this problem wouldn't go away (as far as I can reason).  Buffett alluded to this, IIRC, in some interviews not that long ago.

 

Yet, they do serve a constituency.  

 

It seems like the major ratings agencies provide cover (read: job protection) for a lot of investments by major pension funds and other large corporate investors in a fiduciary (or similar) situation.  Even Berkshire comments (in its annual report and Q's) on the ratings given to its bond investments.  It may be required to do so but even if that's the case, that's still a moat, no?

 

When Moody's got to $18 recently, I almost posted on it but it didn't spend long there.  The recent swoon was caused by a court decision that, as I understand it, removed a legal protection they had relied on to protect them from liability for their ratings decisions.  I believe it was a 1st amendment issue.  I guess there is a chance they get bankrupted if enough cases go against them.

 

I'd be surprised if Buffett thinks that the moat is permanently damaged and yet the sales suggest that is exactly what he thinks...esp. as the sales have continued even though he's gotten the position below 20% (above where it was an equity method investment).  Maybe he is just selling because he's annoyed at the downgrade but that's not reallly his style (in my opinion).  

 

If Moody's does retain its dominant position (and keeps its massive returns on tangible equity), it is probably cheap below $20.  I don't think I'm smart enough to figure it out but when I contemplate what they would be replaced with, I tend to think it is worth a risk at some price.

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WEB and Moodys go back a long way.  He read all their

manuals cover to cover when he was young.  (I did the same

thing at a much later date but stopped at volume V when

I realized I was obsessing.  Yuck!)  Moody's is obviously

impaired to some degree, but how much is problematic.  The

big Democrats in Congress still like them, so it looks

like they will still be in the same government sanctioned

oligopoly when the lawsuits play out.  If I had to

handicap them I would guess they have lost half their

intrinsic value, partly reputation loss, but mostly

loss of the mortgage market which would have occurred

even if they had passed on the dodgy stuff.  Nevertheless, if

I were Buffett, I would be really ticked off at them.

Therefore BRK,s Moody's shares may be a big overhang on

the market for some time to come!

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The thing I wonder about is "What exactly is broken?"  Obviously companies and funds still need the ratings.  Today the problem is that the ratings, if I remember correctly, are paid for by the funds that are being rated.  That's a terrible conflict of interest.  But those companies/funds buying funds still need ratings.  One idea I heard thrown around was that the companies who are buying should pay Moodys and others for the ratings.  That would remove the conflict of interest.  So if Moodys can change the payer, maybe the business still works?

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The thing I wonder about is "What exactly is broken?"  Obviously companies and funds still need the ratings.  Today the problem is that the ratings, if I remember correctly, are paid for by the funds that are being rated.  That's a terrible conflict of interest.  But those companies/funds buying funds still need ratings.  One idea I heard thrown around was that the companies who are buying should pay Moodys and others for the ratings.  That would remove the conflict of interest.  So if Moodys can change the payer, maybe the business still works?

 

I don't see any conflict of interests with Moody's being paid to rate a company. The same thing happens often enough with UL, CSA, ETL, etc... in the engineering side. Strict procedures are setup exactly to avoid any conflict of interest and the whole subjective aspect of evaluating something dissipates. The rating agencies become drones that add up numbers in a form regardless if it makes sense. The model is not doomed, it is just broken... make the forms more intelligent, you know, by having someone think about the numbers behind them before signing the document.

 

BeerBaron

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  • 5 weeks later...

Rabbit,

 

Seth Klarman seems to think that trust was a big part of the rating agencies business.  CDO buyers certainly relied on the trustworthiness of the rating agencies.  That trust and reliability was central to their business model and it's now gone; hence, Buffett dumped them as an investment because the moat has disappeared.

 

http://www.gurufocus.com/news.php?id=77901

"Credit rating agencies were central to the disaster that played out. These formerly trusted assessors of credit quality had completely let down their guard over the last several years, blessing as investment grade a shocking large volume of securities backed by loans that should never have been made. One of their biggest mistakes was not understanding their central place in the virtuous circle that enabled, and even encouraged, the uncreditworthy to falsify loan applications to become homeowners. When these mortgages were pooled, sliced and diced, and securitized, they allowed dross to briefly become investment grade gold. CDOs holding junior tranches of subprime mortgage securities were able to carve up BBB-subprime mortgage tranches into large slugs of AAA rated paper, a modern-day financial alchemy based on backward-looking computer models and credulous buyers. Yield gluttons foolishly trusted these ratings enough to risk complete loss of principal for a handful of basis points of promised incremental return."

 

-O

 

I don't think that the moat relied upon trust and reliability. Moody's, S&P, and Fitch provided communication assistance; users could attach a rating to a security as a shorthand for relative performance. I don't think you will find many pension fund managers who actually believed that the ratings agencies provided thorough due diligence.

 

It's kind of like the FICO score. No one in finance thinks it replaces analysis, but it provides a standardized shorthand for less rigorously formed notions of quality. A bull market can stimulate activity to the point that the users only use the shorthand because they drank the kool-aid or they planned on passing the buck.

 

I'm curious to see what will happen with the ratings system. Moody's might not survive, but it doesn't mean that it's replacement will be any better.

 

The business model has been broken for Moody's; their moat was based on trust and credibility to demand outsized margins in a market where a few suppliers could be trusted enough to evaluate and grade securities traded in the aftermarket.  This isn't the Salad Oil scandal -- http://en.wikipedia.org/wiki/Salad_oil_scandal.  When American Express lost money in that swindle, the biz model was still intact and in 1963 the Buffett Partnership put 40% of its assets into that fat pitch.

 

The bet on Moody's has changed and a permanent capital loss has been incurred.  Ergo, don't lose more capital and salvage what you can -- see Rule#1 in investing.

 

-O

 

 

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Maybe, but I haven't seen a big increase in unrated securities, nor have I seen a major company quote their Egan-Jones rating. In addition, despite the scoffing at the big three ratings, many lenders still include provisions for changes in ratings from the "major" ratings agencies.

 

You and Seth Klarman may prove correct in the future, but it's difficult for me to imagine that a high speed financial world (like the one we have, for now) will demand truly rigorous, issue-by-issue analysis. There's only so much trust to go around, and only so many gurus. For everyone else, it's just a lot easier to tell your clients that all your assets are highly rated.

 

 

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