Warren Buffett on Who's at Fault for the Financial Crisis: Everyone

Warren Buffett
Warren Buffett

Billionaire Warren Buffett on Wednesday delivered a pretty demoralizing explanation of the origins of the financial crisis before a panel that's investigating that very issue. The proceedings' intent was to examine the role Moody's (MCO) -- in which Buffett is a major shareholder -- and the other ratings agencies played in the housing bubble. And in that plain-spoken, affable, avuncular style that he has, The World's Greatest Investor essentially said this: We are all of us, himself included, a bunch of junkies -- and history shows that markets will always oblige us with a fix.

"Rising prices are a narcotic that affects the reasoning power of people up and down the line, even people who should have had the experience," Buffett told the bipartisan Financial Crisis Inquiry Commission (FCIC) in a hearing at The New School in New York City. "Isaac Newton participated in the South Sea bubble. Originally got out. And then he couldn't stand prices going up any longer and so he went back in and got cleaned. And this was a fellow who was generally regarded as being pretty bright."

Now, it's no secret that Buffett is brilliant at extolling the virtues of his investments. Even after paring Berkshire Hathaway's (BRK.A) (BRK.B) stake in Moody's to 17% from 20%, he still owns about $3.4 billion of the rating agency. The stock jumped a few percentage points on Wednesday to almost 20 bucks a share, but as Buffett said more than once, if he knew there was a bubble and it was going to pop, he would have bailed out of Moody's back when it was at $62 (see chart).

Not incidentally, Buffett loves Moody's stock because he "hates" the fact that it has a duopoly with McGraw Hill's (MHP) Standard & Poor's on rating debt. As the only games in town, they have -- or had -- tremendous pricing power. Berkshire and other debt issuers can't shop around for lower prices on their credit ratings. So if you can't beat them, join in the profits. Of course, Buffett pared his Moody's stake in part because regulatory reform could narrow Moody's margins -- and the gusher of cash that they generate.

And that was the crux of Buffett's kind-of-lame but not unreasonable defense of the ratings agencies. Even the Oracle of Omaha can be blind to bubbles -- and he's studied them all. "The entire American public was caught up in a belief that housing prices could not fall dramatically," Buffett said. "Fannie Mae (FNM) believed it. Freddie Mac (FRE) believed it. Congress believed it. I believed it."

So why come down on a CEO -- in this case Moody's Raymond McDaniel -- for making the same mistake as 300 million other Americans? No one knew more about mortgages than Fannie and Freddie, Buffett said, seeing that they were guaranteeing 40% of all the mortgages in the U.S. They had data on millions and millions of mortgages, borrowers, brokers and everyone in between. "And in a March 2007 report to congress, Fannie and Freddie said that their mortgage quality was good," Buffett said.

That doesn't necessarily excuse the ratings agencies, Buffett was quick to add, but it does help explain why they were just as stupid as almost everyone else. After all, hedge-fund billionaire John Paulson, who made the most profitable trade ever by shorting the housing market, looked like a crackpot back in 2005 and 2006.

History Lesson on Market Psychosis

So, yeah, maybe it's a lame defense: Don't blame Moody's -- blame the bubble. But the commission wanted Uncle Warren to answer some questions, and so he came to talk. (True, Buffett didn't show up voluntarily -- he was subpoenaed -- but he was hardly on the hot seat. When you're The World's Greatest investor, everyone wants a piece of you. If he shows up at one of these things, he'll get asked to a dozen more, Buffett told CNBC -- and you know, he's sort of busy running Berkshire Hathaway.)

The FCIC is trying to figure out how the entire financial system blew up -- they have a report due by the end of the year -- and Buffett gave them a history lesson on market psychosis. The rating agencies -- Moody's and McGraw Hill's (MHP) Standard & Poor's -- were no more tragically myopic than anyone else. Their analytical models had the same horrendous flaw, one shared by the entire American public, which said residential house prices can't take a dive, and they won't take a dive all over the country all at the same time.

"They made the wrong call," Buffett said. "I was wrong on it, too. That is the nature of bubbles. They become mass delusions of sorts."

Click here for European efforts to curb ratings agencies.