Warren Buffett on Credit Rating Agencies, Moody's, S&P, Bonds, and Corporate Shareholders

While suing Standard & Poor’s for fraud, states from New Jersey to California ironically are helping fund the world’s largest credit rater’s legal defense by requiring that their pension funds use its rankings.

New Jersey, which sued S&P and its parent McGraw Hill Financial Inc. on Oct. 9 for misleading investors about the independence of its ratings, mandates that the retirement funds of state workers buy securities graded by S&P, Moody’s Investors Service or Fitch Ratings. California, which called S&P a “toll collector” in a February lawsuit, requires investments in its Public Employees’ Retirement System to be rated by S&P and Moody’s, according to the bylaws.

Six years after the start of the worst financial crisis since the Great Depression, about $440 billion in retirement funds for workers ranging from firefighters to teachers from Iowa to Mississippi still must be invested in debt blessed by the firms even though they contributed to the turmoil by incorrectly grading mortgage bonds. Federal rules to promote competition haven’t reduced the dominance of the three firms, which provided 96 percent of all ratings in 2011, according to a U.S. Securities and Exchange Commission report in November 2012.

“The mandate is just a mistake,” Lawrence White, a professor at New York University’s Leonard N. Stern School of Business, who has testified before Congress on ratings companies, said in a telephone interview. “It generates a check-the-box-type process, which can lead to major mistakes and unfortunately that’s what happened” in the last crisis.