Why Warren Buffett Is Right to Knock Standard & Poor's

Now Standard & Poor's is just asking for it. It's one thing for the credit rating agency to soil Uncle Sam's credit, but take on Warren Buffett? Next on the rating agency's to-do list -- dis Mom and desecrate an apple pie.

S&P suggests it had no choice but to lower the outlook on Berkshire Hathaway (BRK) and four other insurance companies to "negative," from "stable," after moving last week to downgrade U.S. government debt from AAA to AA+. The rating firm's rationale? The affected insurers hold lots of Treasury bonds. Knocking down the country's credit rating another notch or two would also result in a similar cut for insurance carriers, S&P said.

On the other hand, the firm said the insurers' credit profile is as strong as ever. Huh? Oh, let's just allow S&P to explain:

Rather, the rating actions reflect the application of criteria and our view that the link between the ratings on these entities and the sovereign credit ratings on the U.S. could lead to a decline in the insurers' financial strength. This is because these companies' businesses and assets are highly concentrated in the U.S.

The problem with that logic is two-fold. First, as many pundits have pointed out in wake of the U.S. credit downgrade, S&P is, uh, unreliable. Yes, the credit raters have a better record evaluating corporate debt than, say, deciphering the mysteries of mortgage-backed securities. Still, S&P is the company that on Sept. 12, 2008 -- one business day before Lehman Brothers christened the financial crisis by going bankrupt -- rated AIG's credit as AA-, meaning the company had a "very strong capacity to meet financial commitments." Oops.

Second, S&P's premise for furrowing its brow at a company like Berkshire is only meaningful if you believe the rating firm has any special insight into global economic and political affairs. Anyone who has spent more than five minutes around Wall Street knows that it doesn't.

No secret sauce
Take S&P's swing-and-a-miss on the meltdown in Europe. The firm rated Ireland's sovereign debt as AA until at least mid-2010, well after the magnitude of the country's economic problems had become apparent. In late 2009, the firm still adjudged Greece's rapidly deteriorating economy stable enough to merit a A- rating.

By the same token, there is no reason to think that the firm's judgment of America's creditworthiness is any more acute. Notes Columbia University finance prof and investment manager Richard Robb:

Even if we could convince ourselves that rating agencies had insight into emerging countries, it's a big stretch to suppose this translates to superpowers....

[R]ating big countries is thoroughly ridiculous. This is not to say that big countries can't default -- of course they can, and someday even the U.S. might. But we can all look at the same budget numbers and assess the political prospects as well as S&P. Like forecasting stock market indices, no one has any special magic.

But Buffett's larger point holds -- bondholders have largely shrugged off the Treasury downgrade. And it is the financial markets, not credit firms, that represent the final word on America's economic standing. Even corporate bonds, which got a whipping on Monday when stock markets tanked, are firming up in a sign that investors still have confidence in U.S. companies.

In some ways, of course, you almost have to admire S&P's moxie.... or whatever it is that impels people to leap off bridges for sport. Not many companies would pit their tarnished credibility against the Oracle of Omaha and the full faith and credit of the U.S. government. I know who I'm betting on.

Image by Mark Hirschey via Wikimedia Commons, CC 2.0
Related:

• The Sokol Affair: How Warren Buffett Killed "Warren Buffett"
• S&P Downgrade: The Real Risk Is Europe, not the U.S.
• U.S. Credit Downgrade: Don't Sweat the Small Stuff
• Would a U.S. Credit Downgrade Smash the U.S. Economy -- or Just Dent It?
• Why Warren Buffett Lost His Faith -- and Money -- in Bank of America