Moody's, S&P Are Unstoppable
NEW YORK (
) -- Warren Buffett is selling the stock, the lawsuits against the company are gaining ground, but
Moody's Ratings Service
(MCO) - Get Report
and
McGraw Hill's
(MHP)
Standard & Poor's provide a service that we, as human beings, are simply unwilling to do without.
The ratings agencies are facing heavy selling pressure after a judge rejected their longtime defense that they are protected from litigation because their ratings are mere opinions and should be protected as free speech under the First Amendment.
Adding to the damage was Buffett's
Berkshire Hathaway
(BRK.A) - Get Report
, a major Moody's shareholder, which cut its stake in the beleaguered credit ratings agency for the second time in less than two months.
Moody's shares were down 6.90% Thursday and another 11 cents in recent trading Friday. McGraw Hill dropped more than 10% Thursday and was adding 32 cents on Friday, buoyed by a report from Jefferies & Co., which reiterated its "buy" rating.
Jefferies analyst Brian Shipman prefers McGraw-Hill to Moody's, because it trades at a lower earnings multiple and has a publishing business, which offsets weakness in credit ratings. Shipman believes federal spending on education will be a bigger benefit to the textbook industry -- in which McGraw-Hill is a major player -- than other analysts are counting on.
Shipman writes that the court decision may not be as bad as the markets are saying it is. Judge Shira Scheindlin of the New York Southern District decision on Thursday ruled that ratings on securities sold to a select group of investors shouldn't get free speech protections, according to an article in
The Wall Street Journal
Thursday.
The case was brought by plaintiffs Abu Dhabi Commercial Bank and King County, Seattle, who allege Moody's and S&P botched their ratings on a nearly $6 billion structured investment vehicle called Cheyne Finance, which went bust in 2007.
Citigroup
(C) - Get Report
,
Bank of America
(BAC) - Get Report
and
JPMorgan Chase
(JPM) - Get Report
are among the big financial institutions to have held stakes in such SIVs.
Shipman notes that the case is still in an early phase, and could ultimately go against the plaintiffs. He also says it is a "high hurdle" to prove that the ratings agencies defrauded investors in the SIV by giving it a higher rating than it deserved. Among things the plaintiffs will have to prove is that the ratings agencies knew they were providing misleading information.
"A misinformed opinion is not a fraudulent one," Shipman writes.
Shipman makes good points, though the plaintiffs can point to a notorious email exchange between S&P analysts, in which one wrote to the other that a particular security "could be structured by cows and we would rate it." You never know what will happen in a courtroom, but Moody's and S&P are vulnerable, to say the least.
But the fact that an industry is vulnerable to lawsuits does not mean its life is over. Look at the tobacco industry, after all, or the drug companies.
Pfizer
(PFE) - Get Report
and
Altria
(MO) - Get Report
have lost more than their share of legal battles, but they are still very much alive and kicking.
Many people believe the ratings agencies serve no useful purpose. These critics include famous hedge fund investor David Einhorn of Greenlight Capital, who has said on several occasions he has a short position in Moody's.
What Einhorn and others may not fully appreciate is the degree to which we, as a society, are ratings-obsessed. That's why business magazines constantly offer lists of top 10 stocks to buy, top analysts, top money managers. We don't like thinking. Who has time? What's the rating?
That mindset is far more prevalent, and powerful, than the argument of any attorney. Ultimately, it will buoy the shares of Moody's and S&P.
--
Written by Dan Freed in New York
.
