Strip ratings agencies of their special status
Everyone else was mistaken, so why not the credit ratings agencies? That was effectively Warren Buffett's defence of Moody's, Fitch, and Standard & Poor's over the role they played in the subprime mortgage crisis. But this is not really a defence at all. We expect such professional agencies to guide investments wisely, not to follow the herd. Otherwise, why give them so much authority over the bond market, making their highly profitable ratings gospel to corporations, pension fund managers, governments, and even regulators and central banks?
Buffett had to be subpoenaed to testify before a hearing of the US Financial Crisis Inquiry Commission, which is mandated to determine the causes of the global financial crisis. His performance presented a revealing - if less flattering - side. The world's most famous investor is used to being adored by fans around the world for his folksy investment advice and outspoken criticism of the more egregious practices of Wall Street. He famously called the more exotic derivatives 'weapons of mass destruction'. However, after the onset of the financial crisis it was revealed that his flagship holding, Berkshire Hathaway, has a massive derivatives portfolio.
Berkshire is also the largest investor in Moody's, even though it has lightened its holdings since the agencies came under criticism for giving AAA ratings to toxic mortgage-backed securities which turned into junk when the US housing market collapsed. Therefore, he had a serious profit motive to speak well of the agencies - and defend the indefensible. The Oracle of Omaha's pronouncements on things financial are usually worth listening to, but this time people will have to look beyond Buffett for enlightenment.
Notwithstanding his defence, moves are afoot to put the ratings agencies under regulatory oversight in the US and the European Union. This is a start, but it does not go far enough. They should be stripped of the semi-official status accorded them by law and accounting standards. They could still carry on with their ratings, but these would be for reference rather than gate-keeping purposes. Investors, then, would have to do their homework rather than outsourcing it to the agencies.