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Buffett, Einhorn Fight Breaks Out as Government Charges S&P With Fraud

Stocks in this article: MCO MHP MS BRK.A BRK.B GMCR

Einhorn, who correctly predicted the demise of Lehman Brothers, stuck with the short bet against Moody's despite the fact that it's lost ground since being unveiled in the wake of the crisis. Buffett, meanwhile, has slightly pared his Moody's stake since Einhorn conveyed his short bet, and he's even defended the company in front of congressional panels to stinging criticism.

Now, with only one private investor count remaining against Moody's and its competitor, S&P, the score between Einhorn and Buffett is likely to be settled once and for all.

The contest between Einhorn and Buffett pits conflicting opinions on the extent to which Moody's and S&P can be held financially responsible for mortgage bond ratings that proved to be wildly inaccurate after the housing bust.

Cutting against Einhorn's short bet on Moody's, many remain unconcerned about the lawsuit and are just one verdict away from having significant legal risk from the crisis removed. Buffett also appears highly confident.

Since 2010, The Oracle of Omaha, as Buffett is known, pared his stake in Moody's to roughly 13%, but he remains a top shareholder, according to recent filings with the Securities and Exchange Commission.

One-year share gains in excess of 25% and analyst optimism on Moody's long-term prospects signal that some are advising against Einhorn's bearish views.

"While the Abu Dhabi case likely moves to trial in Feb. 2013, the company views the large number of favorable precedent decisions (and lack of "smoking gun" from extensive discovery) as strong indicators of a positive outcome," wrote Piper Jaffray analyst Peter Appert in a Sept. 13 note to clients upgrading Moody's 2012 and 2013 earnings estimates. Strong debt markets and bond issuance amid record-low interest rates are proving a tailwind for Moody's, he said.

On Tuesday, Appert noted an increase in near-term litigation risk given the government's civil fraud charge against S&P, but the analyst maintained optimism on the long-term prospects of both agencies.

"Although numerous embarrassing and unprofessional emails have been uncovered (with more to come), they have not served to provide evidence of fraud on the part of the rating agencies," Appert wrote Tuesday.

In October, Einhorn conceded in the near-term that his short position could continue to suffer a rebound in Moody's earnings.

Still, he pointed to the Cheyne SIV trial to vindicate what's been a slow-burning short bet. Were fraud to be proven, other investors in securities rated by Moody's during 2007 and 2008 may choose to sue ratings agencies before their rights expire, Einhorn said in October.

Both Einhorn and Buffett have sparred publicly on their differing views of Moody's.

In a June 2010 testimony to legislators, Buffett defended rating agencies, noting that Moody's shouldn't bare all of the blame for the crisis. "Look at me. I was wrong on it, too," Buffett said about the housing market, which he said was the biggest bubble he's ever seen.

Buffett was excoriated in the press for his testimony, and in a Bloomberg TV interview, Einhorn subsequently pressed his short, questioning both the credibility of Buffett and the agencies.

Investors should watch for a February trial on fraud charges leveled against Moody's to settle the score between Buffett and Einhorn. The suit could also be a leading indicator as to whether the DoJ's claims against S&P or any other ratings agency bear fruit.

"We allege that, by knowingly issuing inflated credit ratings for CDOs (collateralized debt obligations) -- which misrepresented their creditworthiness and understated their risks -- S&P misled investors, including many federally insured financial institutions, causing them to lose billions of dollars," U.S. Attorney General Eric Holder said in a statement Tuesday.

In addition, "we allege that S&P falsely claimed that its ratings were independent, objective, and not influenced by the company's relationship with the issuers who hired S&P to rate the securities in question -- when, in reality, the ratings were affected by significant conflicts of interest," Holder added.

The DoJ's civil fraud charges were brought under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, which allows the government to seek civil penalties equal to the losses suffered by federally insured financial institutions. To date, the DoJ has identified over $5 billion in federal losses resulting from CDOs that were rated by S&P between March and October 2007, according to Holder.

"A DOJ lawsuit would be entirely without factual or legal merit," S&P said in a statement Monday. "It would disregard the central facts that S&P reviewed the same subprime mortgage data as the rest of the market, including U.S. government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained."

-- Written by Antoine Gara in New York

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