In
the Presidential debates in October, both Barack Obama and
John McCain, came up with the same name to save the reeling
American economy: Warren Buffet, the 78 year old chairman
and largest stockholder of Berkshire-Hathaway, a $120 billion
holding company. Known in the media as the “Oracle
Of Omaha,” he had condemned derivative contracts as
early as 2003, describing them “as time bombs, both
for the parties that deal in them and the economic system.”
After derivative contracts on sub-prime mortgages had delivered
a near death blow to the financial system in October 2008,
he told Charlie Rose in an hour-long televised interview
that such derivatives were nothing short of “financial
weapons of mass destruction,” saying, “They
destroyed AIG. They certainly contributed to the destruction
of Bear Sterns and Lehman.” It light of his lucid
explanation of their incredible perils, it seemed gratuitous
for Charlie Rose to then ask Buffet if he himself had trafficked
in derivatives, If he had asked, the Buffet’s answer
might have been surprising since, at the time of that interview,
Buffet’s holding company not only had multi-billion
dollar positions in derivative contracts but it was the
largest single shareholder in one of the principal enablers
of the proliferation of sub-prime mortgage derivatives.
As subsequently revealed in Berkshire Hathaway’s third
quarter 10-K filing with the SEC in 2008, the Oracle turned
out to be one of America’s largest seller of derivative
contracts. Not only had he sold over $2.5 billion worth
of credit default swaps in 2008– the same notorious
derivative contracts that had brought AIG to its knees–
but he had sold over $6.7 billion worth of another type
derivatives, called “index put option contracts”
that essentially bet stock prices would not fall here and
abroad. These contracts have a duration of as long as 20
year, and, as the disclosure notes, “generally may
not be terminated or fully settled before the expiration
dates and therefore the ultimate amount of cash basis gains
or losses may not be known for years.” Even for the
first nine months of 2008, Berkshire’s losses from
these derivative already were $2.2 billion.
But Buffet’s involvement in the derivative casino
went beyond selling credit default swaps and put options.
After Moody’s Corporation, the second- largest credit-rating
company, went public in 2000, he had Berkshire Hathaway
buy 48 million shares in it– approximately a twenty
percent stake– making it by far Moody’s largest
shareholder. The role Moody’s was to play in the proliferation
of sub-prime mortgage , along with that of the two other
rating agencies, Standard & Poor’s and Fitch Ratings,
is lucidly described by Nobel laureate economist Joseph
Stiglitz in an interview with Bloomberg News: “I view
the ratings agencies as one of the key culprits, They were
the party that performed that alchemy that converted the
securities from F- rated to A-rated. The banks could not
have done what they did without the complicity of the ratings
agencies.''
The sad history of Moody’s race to the bottom began
after it was spun off by Dun & Bradstreet Corp. in September
2000 and after Buffet had invested $499 million in it. Prior
to that, Moody’s was a stodgy company in the low-profit
business of evaluating credit data supplied to it largely
by triple-A companies. The SEC had given it, along with
S&P and Fitch’s, an effective lock on the issuance
of credit ratings. So the giant corporations needed to get
its top rating (AAA, meaning little or no risk) in order
to sell their bonds to insurance companies, pension funds,
and other regulated institutions. But with the mushrooming
of mortgage-back securities, Moody's found a much more profitable
business line: rating pools of mortgages called Collateralized
Debt Obligations (CDOs). Working on the theory that if these
CDOs were structured into different tiers, it could award
Triple A ratings to the safer tiers, which, in turn, would
allow underwriters to sell CDOs to institutions, Moody’s
made additional money advising the underwriters how to structure
their CDOs in such a way so that it could provide top ratings.
Once they received these ratings they could leveraged them
over and over again via so called “piggy back”
loans.
Even though sub-prime mortgages accounted for about half
of the collateral on CDOs, Moody's manage through this theory
to assign triple A grades to nearly 75 percent of them.
In August 2004, to get an even larger share of this business,
it revamped its credit-rating formula in such a way that
it could issue top-ratings to even a larger portion of sub-prime
debt. Not to lose market share, Its chief competitor, S&P,
followed suit the next week. By 2006, the market for rated
CDOs had exceeded $3 trillion.
This enterprise entailed an obvious conflict of interest
since Moody’s was being paid by very companies it
was rating, but the profits were so enormous it was overlooked
by everyone involved. By extracting almost three times the
fees on structured CDOs than it got on conventional corporate
debt, Moody’s took in an incredible $3 billion between
2002 and 2006. And since it had operating margins above
50 percent on its rating work, most of this new found El
Dorado was profit. When Moody’s stock soared, it increased
the market value of Buffet’s stake from $499 million
in 2001 to $3.2 billion in February 2007. The Oracle of
Omaha thus made $2.7 billion profit from the very “time
bombs” he was at the time public ally damning. Moody’s
ratings meanwhile enabled these derivatives to spread like
kudzu throughout the global financial pipelines until the
entire house of cards collapsed in 2008. Moody's then had
to downgrade more than 90 percent of all asset-backed CDO
investments issued in 2006 and 2007, and Buffet, alas, lost
a good part of the windfall
It is hardly conceivable that Buffet, who famously prides
himself on the scrutiny he gives to companies in which he
invests, could not have known that the heart of Moody’s
money machine was certifying hundreds of billion dollars
worth of CDOs for purchase by banks and other institution.
If he didn't’t know that, what kind of Oracle is he?
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