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Let's Face It: S&P's Analysis Is A Joke... But It Still Has A Right To An Opinion

from the you-probably-just-shouldn't-believe-it dept

There's been a lot of attention paid to S&P over the past couple weeks, after it was the first of the big three credit rating agencies to "downgrade" US debt. As we pointed out at the time, it's pretty ridiculous to get worked up over the downgrade, because it's just one company's opinion. And, yes, for very ridiculous reasons, the opinions of a few ratings firms are written into the law, and some debt holders are required to hold certain types of debt based solely on the opinions of these companies. The real problem is that such opinions matter. In fact, as many commentators noticed, after the S&P downgrade, people actually rushed to buy up more US debt, driving down the cost, which is the exact opposite of what you would think should happen.

Of course, S&P has other problems. Nate Silver did a brilliant (as per usual) takedown of "Substandard and Pourous," in which he noted that S&P's ratings are pretty dreadful. He goes through the data and shows that listening to S&P will make you poorer. Basically, lots of other information will give you a much better indicator of the likelihood of default on sovereign debt. The specific problem?
S.&P. ratings tend to lag, rather than lead, the market. That is, in cases where the market’s view of default risk is misaligned with S.&P.’s, S.&P. is a good bet to change their rating to catch up to market perception.
And, of course, lots of people have pointed out how poorly S&P did in the housing bubble, rating crap bundles of mortgages as investment grade when it was clearly junk. Then there's other general sleaziness. Pro Publica points out that S&P -- who, it should be mentioned, apparently made a $2 trillion "error" right before downgrading the US debt, is apparently lobbying against a regulation that would require it to report "significant errors."

But does this, as some have suggested, mean that S&P should get into some sort of legal trouble? Michael Moore even made the ridiculous suggestion that the company's CEO should be arrested. Really? You would think that Moore, who has been pretty damn critical of US government policy over the years, would think twice before thinking that someone should be "arrested" for stating an opinion that was critical of the government's ability to repay its debts.

But, of course, we still have some of the First Amendment, and that means you can state an opinion -- even one that turns out to be wrong or useless -- and not be arrested for it. Once again, the real issue is this idea that we need a ratings agency to determine the quality of debt. In the equity world, plenty of investment banks issue "ratings" on the equity (usually some form of "buy, sell, hold") but no one takes them quite as seriously as the debt ratings from S&P, Moody's and Fitch. Again, I'd argue that this is because of the requirements in law about the kinds of debt certain operations can hold, and tying that to just a few opinions. If we had the same rules for equity, we'd see a very different stock market today. Sure, when a big bank downgrades a stock, people sell, but people implicitly recognize it's an opinion. When it comes to debt, something about the ratings system and the requirements about it makes people think that the ratings are more "fact" than opinion.

So, let's get away from that entirely. Let's dump the requirements that any debt holdings should be required of certain levels based solely on the opinions of these ratings agencies with terrible track records. Instead, what's wrong with just letting the market price decide how trustworthy the debt is? You don't have to do away with ratings entirely. Anyone can have an opinion. But without the requirements that make just a few firms integral to the market, you could have a lot more open competition on who really has the best opinion on the viability of certain debt.

So don't arrest the head of S&P. But, stop giving the ratings from these few firms special status that makes people think they're something more than just a random company's opinion.


Reader Comments (rss)

(Flattened / Threaded)

  1.  
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    Richard (profile), Aug 15th, 2011 @ 4:13pm

    What the law actually requires

    is not that you don't ever lose all your client's money in a bad investment - rather that you don't lose all your client's money in a bad investment - except when everyone else is doing it too

     

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    PrometheeFeu (profile), Aug 15th, 2011 @ 4:31pm

    I think it doesn't make much sense to keep bringing up the whole mortgage debacle. Yes it was bad, but the situation is totally different. The ratings were issued by different departments and different people. The ratings in the mortgage crisis supposedly understated the risk of default while here S&P is accused of overstating the risk of default. The debt issuers paid S&P for the ratings which led to all sorts of conflicts of interest and shenanigans where the issuers would restructure deals with S&P's help to get AAA while here, I don't think S&P worked with the US government to let it restructure their debt to get a downgrade. Overall, I don't think the two are linked.

     

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  3.  
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    Anonymous Coward, Aug 15th, 2011 @ 4:47pm

    FUD Busters

    "The error came about because S&P took the amount of deficit reduction CBO calculated from the Budget Control Act and applied it to the wrong starting point, or “baseline.”

    Specifically, CBO calculated that the Budget Control Act, including its discretionary caps, would save $2.1 trillion relative to a “baseline” in which current discretionary funding levels grow with inflation.

    S&P incorrectly added that same $2.1 trillion in deficit reduction to an entirely different “baseline” where discretionary funding levels grow with nominal GDP over the next 10 years. Relative to this alternative “baseline,” the Budget Control Act will save more than $4 trillion over ten years – or over $2 trillion more than S&P calculated. (The baseline in which discretionary spending grows with nominal GDP is substantially higher because CBO assumes that nominal GDP grows by just under 5 percent a year on average, while inflation is around 2.5 percent a year on average.

    The impact of this mistake was to dramatically overstate projected deficits—by $2 trillion over 10 years. As anybody who has followed the fiscal discussions knows, a change of this magnitude is very significant. Nonetheless, S&P did not believe a mistake of this magnitude was significant enough to warrant reconsidering their judgment, or even significant enough to warrant another day to carefully re-evaluate their analysis."

    -From the Treasury

    Mike, hollering about a $2 trillion error in this situation is kind of like saying that Apple has more $ than the U.S. Government. Yeah, there is a $2 trillion difference if you assume a 5% perpetual growth rate (the USG method using a high GDP growth rate, which IMO is bullshit) versus using a 2.5% growth rate (the S&P method using inflation, a more conservative projection). I have seen this FUD all over the net and just wanted to make the people aware of exactly what this $2 trillion error is. The U.S. will not have a 5% long term nominal GDP growth rate!

     

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  4.  
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    Anonymous Coward, Aug 15th, 2011 @ 4:50pm

    Seditious opinions

    You would think that Moore, who has been pretty damn critical of US government policy over the years, would think twice before thinking that someone should be "arrested" for stating an opinion that was critical of the government....


    No.

    Experience tends to show that most people are not reflective, or self-critical. And if they've been threatened with jail over their opinions, then they're usually more likely to support jail time for other people's opinions, attitudes, religion.

     

     

    It's just fucked up.

     

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  5.  
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    Jordan (profile), Aug 15th, 2011 @ 4:56pm

    Michael Moore even made the ridiculous suggestion that the company's CEO should be arrested.


    But this can be the fun part of corporations as people. Throw all the employees in jail.

     

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    PrometheeFeu (profile), Aug 15th, 2011 @ 5:18pm

    Re: FUD Busters

    It seems to me S&P's decision to downgrade was largely because of political factors. It is true that if the politicians keep playing chicken over the debt ceiling, there could be a time when neither will swerve in time and they run off the cliff. It is unlikely (if anything because the game is not really chicken and they have plenty of options even if the debt ceiling isn't raised) but it can happen as is reflected in the very good AA+ rating the US has.

     

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  7.  
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    PrometheeFeu (profile), Aug 15th, 2011 @ 5:31pm

    Re: Seditious opinions

    Well, Moore is not actually an advocate of free speech. He is an advocate of particular policies and wants to support them at all costs. If that means having to dump the 1st Amendment, I don't think he would care either way.

     

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  8.  
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    ChurchHatesTucker (profile), Aug 15th, 2011 @ 5:34pm

    Re:

    I think it doesn't make much sense to keep bringing up the whole mortgage debacle.

    How 'bout Enron?

    As for 'conflict of interest' in this case, see the point about impending regulation by the US government.

     

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  9.  
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    out_of_the_blue, Aug 15th, 2011 @ 5:59pm

    A confidence racket requires confidence men.

    They wear $3000 suits and make out like the bandits that they are. They're an important part of the Establishment pushing specific propaganda.

    AND YET here's Mike's characteristic corporate-friendly non-sequitur, from first accusing them of fraud:
    "And, of course, lots of people have pointed out how poorly S&P did in the housing bubble, rating crap bundles of mortgages as investment grade when it was clearly junk."

    Only to end up protecting those criminals:
    "So don't arrest the head of S&P."

     

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  10.  
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    Killercool (profile), Aug 15th, 2011 @ 6:12pm

    Re: A confidence racket requires confidence men.

    Once again, you take a valid point, and then totally screw it up.
    Please, elaborate. How are they criminals if what they are doing is in alignment with the law? Did you skip the part where not reporting significant errors is not yet illegal?
    And how is Mike protecting the "criminals" by suggesting that the law which allow them to make out like bandits (by forcing adoption of their ratings) be corrected?

     

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  11.  
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    Anonymous Coward, Aug 15th, 2011 @ 6:23pm

    Re: Mortgage Debacle

    "doesn't make much sense to keep bringing up the whole mortgage debacle"

    Yes, it does. The mortgage debacle was a symptom of the culture of scheming which has infected just about all of the US finance industry. That culture is still there and shows no sign of going away. Why should it? The New York banks made gigantic profits out of it during the mortgage debacle, so why should they give it up?

    The mortgage debacle was also highly significant in that it proved conclusively that the ratings agencies were under the control of the New York banks. They rated junk paper (CDOs) from the New York banks at AAA, despite the fact that they knew full well that it was junk. The New York banks pay the ratings agencies for their opinions, so the New York banks get what they want. Then the AAA-rated paper went down to a price of zero, yes, zero. Investors lost trillions and the New York banks and their friends walked away with the money.

    Then the idiot politicians threw in colossal sums of the taxpayer's money, in defiance of the clearly expressed wishes of the electorate. Furthermore, none of the bad guys went to jail. Alas, predators are smarter than the prey.

    Drive around some of the swanky suburbs near New York, sometime. Ask yourself, "Who is paying for all this?" You are, Americans, by not being suspicious enough when dealing with your own finance industry. If you want to get back to prosperity, full employment and balanced budgets, then start remembering the culture of scheming at all times.

     

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  12.  
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    Lawrence D'Oliveiro, Aug 15th, 2011 @ 6:46pm

    Meanwhile, Back In The Real World ...

    Some people are so fixated on this one incident, and ignoring the broader trends. Like the recent sharp declines in Western stock markets, which did not carry over to Eastern ones.

    There is a long-term shift in economic power going on, from North American and European centres to the new Asian powerhouses, and possibly South American ones as well. That’s the news you should be paying attention to. Worrying about this one little credit-rating blip is just a waste of time.

     

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  13.  
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    Anonymous Coward, Aug 15th, 2011 @ 6:54pm

    I am a conspiracy theorist.

    I know that because I do not believe that the people in DC are stupid because they were smart enough to get there in the first place therefore if they are not stupid and they do things that I think are stupid then it must be that I do not know what is happening or that they are trying to do.

    If they are doing something that I think is stupid and they think is smart it must because I have no idea of what they are really doing.

    Given that, and the fact that a big issue was made over raising the debt ceiling it must be that they are covering up what was really happening behinds the scene. What I no not but it must have been big to rate all that tong wagging.

    But even if nothing was going own that the powers to be want burred the down grade by S&P did set up the biggest Bear Raid.

    Did S&P corporate?
    I dough it.

    Where people at S&P in on this?
    I dough it.

    But some how it got set up and it was no accident.

    See I told you I am a conspiracy theorist.

     

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  14.  
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    FuzzyDuck, Aug 15th, 2011 @ 7:17pm

    Downgrade was entirely correct

    The downgrade was of course entirely correct, but as Mike pointed out, it was lagging behind reality. Still surprised that S&P was the first to downgrade, apparently the other agencies lag even more.

     

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  15.  
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    Anonymous Coward, Aug 15th, 2011 @ 8:17pm

    Pro Publica points out that S&P -- who, it should be mentioned, apparently made a $2 trillion "error" right before downgrading the US debt, is apparently lobbying against a regulation that would require it to report "significant errors."

    I love this bullshit about the 2 Trillion, when S&P took Govt. numbers at face value from may and mac they were later dragged over the coals for poor due diligence. Now when they look at the numbers and make a decision they are again chased by the mob, the numbers from the govt. are more a rosy painting than reality.

    Lets look at a hard monetary fact, in 1955 an average auto cost $2500 an oz of gold was $35.15 so it took about 71oz of gold to buy a car. In 2005 an average auto was $25,000 and gold was $513oz or about 48oz of gold to buy a car.
    Today you can get a good car for $35,000 or about 20oz of gold.

    I would say that the Govt. is not doing a very good job with relation to the economy.

    What surprises me is that we are not at junk bond status.

     

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  16.  
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    SLK8ne, Aug 15th, 2011 @ 10:16pm

    lobbying against a regulation that would require it to report "significant errors."

    Would another regulation do any good? Seems that I recall the SEC had plenty of regulations to enforce and was watching porn instead of doing their job. So what good would yet another regulation do?

    Who is watching the watchmen when the watchmen are watching porn?

     

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  17.  
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    SLK8ne, Aug 15th, 2011 @ 10:26pm

    Re: I would say that the Govt. is not doing a very good job with relation to the economy.

    I agree.

    Though, I don't think that the point of the article was to absolve the government of it's share of blame for this mess.

    Personally, I think this whole melodrama put on in Washington was more of a "political morality play" than a real reflection of the problem. As usual, much sound and thunder and no real change.

    The unfortunate reality is that it took us 50+ years to get into this mess, and it's unlikely we're going to get out of it easily, or soon. (even presupposing anyone in Washington has the will to REALLY deal with the problem, a supposition I find dubious)

     

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  18.  
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    Anonymous Coward, Aug 15th, 2011 @ 11:25pm

    Let's face it, bloggers who glom onto any story that might drive page views are a joke. But it's okay, they are entitled to their opinion.

     

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  19.  
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    Mike Masnick (profile), Aug 16th, 2011 @ 1:50am

    Re:

    Let's face it, bloggers who glom onto any story that might drive page views are a joke.

    You're really reaching. Trust me, stories about Wall St. on a tech/law blog get *shit* for traffic. This is the weakest story of the day, by far. As were the S&P stories from last week.

    It's not about the "traffic." It's about what I find interesting. I think this is interesting.

     

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  20.  
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    Anonymous Coward, Aug 16th, 2011 @ 4:19am

    The ratings are guidance. S&P would be remiss to not point out that the US is bankrupt and will never be able to repay their debts unless they want to roll Weinmar-style.

    You have a goddamn MBA from Cornell University and you post this poop.

    Unbelievable.

    Or maybe not, judging from the rest of your horribly spun missives here.

     

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  21.  
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    Mike Masnick (profile), Aug 16th, 2011 @ 4:35am

    Re:

    The ratings are guidance. S&P would be remiss to not point out that the US is bankrupt and will never be able to repay their debts unless they want to roll Weinmar-style.

    Your reading comprehension gets worse by the day. Did I ever claim that the US wasn't in trouble? No. The only thing I argued was that the S&P's rating change was meaningless in the big picture, and most of the market had already accounted for it. Separately, I pointed out that the S&P has a history of LAGGING the market.

    How you could take that and assume it meant that I thought the S&P was *wrong* I really don't know.

    You have a goddamn MBA from Cornell University and you post this poop.


    And, amusingly, you fail to point out a single thing I got wrong. If you can't contribute constructively, please stop.

     

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  22.  
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    abc gum, Aug 16th, 2011 @ 4:45am

    Re:

    I think you meant doubt rather than dough.
    Good example of how spell checker can mislead.

     

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  23.  
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    abc gum, Aug 16th, 2011 @ 4:51am

    I'm sure many people were and still are in agreement with this sign.

    http://www.flickr.com/photos/stoller/2907411559/

     

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  24.  
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    timlash (profile), Aug 16th, 2011 @ 7:14am

    The Free Market Is Broken

    "Instead, what's wrong with just letting the market price decide how trustworthy the debt is?"

    I can tell you what's wrong with that in two words: Bear Stearns. Here are some market prices for a share of Bear Stearns common stock:

    Jan 2007 - $172
    Feb 2008 - $93
    Mar 12, 2008 - $60
    Mar 14, 2008 - $2

    The market had no idea of the real value of Bear Stearns. Any existing theory of efficient market pricing was utterly invalidated in 2008. While Bear Stearns is the most egregious example of this failing, it is not alone.

    The value revealed by markets merely indicate the price level at which trades will be made. Those trading levels are often wildly unrelated to the underlying value of the thing being traded. In fact, the trade levels are also opinion. They are the current opinions of the buyers and sellers. Those opinions in aggregate ("the market") are no more prone to valuation accuracy than the opinions of the rating agencies. In fact the ratings agencies can at least expose their algorithms and methodologies to the scrutiny of an auditor. The motivations behind most trading is a mystery.

    Mike IS right in that the detailed investment approaches for those acting on behalf of the public should not be dictated by statute. However, perhaps the best investment advice and guidance for pensions and trusts would be caveat emptor.

     

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  25.  
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    Anonymous Coward, Aug 16th, 2011 @ 7:57am

    Re: Re:

    Notice the word "might", not an absolute. I am sure you go on subject fishing expeditions all the time, in part to look for traffic that will appeal to your (often absent) sponsors. How is the deal with HP and UPS going?

     

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  26.  
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    P3T3R5ON (profile), Aug 16th, 2011 @ 10:23am

    so unfortunate

    They may be the 'definition' of the current stock market performance... but I don't trust them (DOW, DJIA, S&P, NASDAQ and any other index). Especially when it comes to the freaking out that everybody does about their 401(k)s.

    That is why you need to be a little more attentive to the 401(k) process and how it works. Honestly I think it is a bad idea from the beginning, pensions are better. However pensions are dying and 401(k)s are now for everybody. But to many people don't understand them or the power they hold for their future.... A little bit of education and a little less trust in the indexes would keep people from having a heart attack every time the market dips over 300pts.

     

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  27.  
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    Anonymous Coward, Aug 16th, 2011 @ 12:13pm

    Re: Re:

    The headline alone is wrong, you buffoon.

     

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  28.  
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    Anonymous Coward, Aug 16th, 2011 @ 4:32pm

    Re: Re:

    Aww didn't get our milk and cookies today? The USA should have been bankrupt years ago. And just now you get mad at random people? Why?

     

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  29.  
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    Mike Masnick (profile), Aug 16th, 2011 @ 5:35pm

    Re: Re: Re:

    The headline alone is wrong, you buffoon.


    What about it is wrong? And is it honestly that difficult for you to respond without an ad hom?

     

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  30.  
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    Isaac, Aug 16th, 2011 @ 6:09pm

    Re:

    Ah, but corporations being legal persons only applies to the advantages of being legal persons. When it comes to the disadvantages, they aren't treated as legal persons.

     

    reply to this | link to this | view in thread ]

  31.  
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    btr1701 (profile), Aug 17th, 2011 @ 10:53am

    Moore

    > You would think that Moore, who has been
    > pretty damn critical of US government policy
    > over the years, would think twice before
    > thinking that someone should be "arrested"
    > for stating an opinion that was critical of
    > the government's ability to repay its debts.

    You've stumbled upon Michael Moore's singular hypocrisy.

    He only believes stating critical opinions of the USA is acceptable when Republicans/conservatives are in charge. Since a Democrat is in charge, Moore believes it's not cool (and apparently criminal) to state an opinion that makes the Democrat look bad.

    Moore is chock full of double standards like this. When a college filmmaker tried to make a documentary about Moore and follow him around and harass him the same way Moore did with General Motors CEO Roger Smith in his own film 'Roger & Me', Moore sued and tried to get a restraining order against the kid.

    Moore is nothing but a hypocritical douchebag who twists facts and tells half-truths to suit his personal agenda.

     

    reply to this | link to this | view in thread ]


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