Warren Buffett | Testimony | 2008 Financial Crisis | June 2, 2010 | Summary and Q&A

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November 12, 2020
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Warren Buffett | Testimony | 2008 Financial Crisis | June 2, 2010

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Summary

This video features a hearing on the credibility of credit ratings and investment decisions made during the financial crisis. The witnesses include Warren Buffett, the chairman and CEO of Berkshire Hathaway, and Raymond McDaniel, the chairman and CEO of Moody's Corporation. The questions and answers delve into topics such as the accountability of rating agencies, the role of management and boards of directors, the accuracy of credit ratings, and potential reforms for the credit rating industry.

Questions & Answers

Q: How did Moody's ratings perform during the financial crisis?

Moody's acknowledges that its ratings for U.S. residential mortgage-backed securities and related collateralized debt obligations were deeply disappointing. Although the company accounted for trends in the housing market, it did not anticipate the severity or speed of the housing market's deterioration. Moody's enhanced credit protection requirements were insufficient to ensure rating stability.

Q: Should there have been a management change at Moody's?

Moody's made management changes in response to the poor performance of its ratings. While accountability is important, the magnitude of the mistake made by Moody's was not significantly different from other market participants and observers. CEO accountability is crucial, but it is also necessary to consider external factors that influenced the housing bubble and subsequent financial crisis.

Q: What should be the role of shareholders and boards of directors in monitoring companies?

Shareholders and boards of directors have a responsibility to monitor companies and address culture problems. In the case of Moody's, the board was not particularly involved in discussing significant issues like the ratings process. Shareholders should consider the consequences of a company's actions and ensure that management accountability is in place. There should also be a focus on long-term consequences rather than short-term profits.

Q: Is the issuer pay model for rating agencies problematic?

The issuer pay model, where issuers pay for credit ratings, creates potential conflicts of interest. Moody's recognizes these conflicts and aims to manage them transparently. Alternative models, such as a consumer reports-like approach where ratings are provided for free, may not be feasible due to the scale and complexity of rating thousands of securities. The key is to address potential conflicts and improve the quality and transparency of ratings.

Q: Should there be changes in the selection of rating agencies by issuers?

The current system involves issuers selecting rating agencies. While alternatives like having a panel select rating agencies may have merit, it is challenging to implement and determine the best approach. The focus should be on managing conflicts of interest and ensuring the objectivity and integrity of credit ratings.

Q: What aspects of the legislation moving through Congress are positive?

Two important aspects to consider are incentives and leverage. The CEO and board of a financial institution should have significant downside risks if the institution requires government assistance. This would incentivize responsible behavior. Additionally, addressing excessive leverage, which played a role in the financial crisis, is crucial. However, it is acknowledged that the legislation may not be comprehensive enough to address all issues.

Q: Should there be clawbacks of executive compensation?

There should be a significant downside for CEOs and boards of directors when mistakes or irresponsibility result in government intervention to save institutions. The current practice of CEOs receiving large payouts even in cases of failure should be reevaluated.

Takeaways

The hearing highlights the need for accountability and reform in the credit rating industry. Moody's and other rating agencies acknowledge the poor performance of their ratings during the financial crisis, particularly in the housing sector. The role of management and boards of directors in monitoring companies and addressing culture problems is emphasized. There is a debate about the suitability of the issuer pay model and potential alternatives. Changes in legislation are seen as a necessary step, focusing on CEO and board accountability, as well as addressing excessive leverage. Overall, the hearing underscores the importance of lessons learned from the financial crisis in reshaping the credit rating industry.

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