Incriminating Emails, ‘Smell of Payback’ in Feds’ Lawsuit Against S&P

Incriminating Emails, ‘Smell of Payback’ in Feds’ Lawsuit Against S&P
February 18, 2013

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)

Standard & Poor’s is the only credit rating agency to have downgraded U.S. government debt, and now it is the only credit rating agency to be sued by the government over its ratings of housing-backed securities. Whether it remains the only one to be sued remains to be seen.

The U.S. government and several states have announced a lawsuit against S&P, claiming the company should have known its ratings on mortgage bonds were too high. The government says the company failed to lower ratings at the start of the housing market crisis in 2006 to protect business it received from banks that were selling the securities.

S&P and the nation’s other two major credit rating agencies recognized by the U.S. Securities and Exchange Commission, Moody’s Investors Service and Fitch Ratings, typically are paid by the issuers of securities they rate.

S&P downgraded its rating of U.S. government debt in August 2011. The other two rating agencies continue to give U.S. government debt their highest ratings, but both have given it a “negative” outlook, indicating downgrades could come.

‘Could Be Structured By Cows’

New York Times reporters Andrew Ross Sorkin and Mary Williams Walsh reported emails and instant messages cited by the Justice Department show S&P staffers knew what they were doing in issuing their ratings. One S&P employee wrote, “Rating agencies continue to create an even bigger monster—the C.D.O. market. Let’s hope we are all wealthy and retired by the time this house of card falters.” Another wrote, “We rate every deal. It could be structured by cows and we would rate it.”

The government is arguing S&P’s ratings of the housing-backed securities harmed federally insured financial institutions and, ultimately, taxpayers.

Many analysts say the government itself is largely to blame for blowing the housing bubble by manipulating lending and housing markets. They note Federal Reserve officials and government economists failed to recognize the imminent collapse of the real estate market and the overvaluation of housing-backed securities.

‘Smells of Payback’

The lawsuit against S&P “smells of payback for S&P’s downgrade of the U,S, government,” said economist John Berlau, director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute in Washington, DC.

In a column for Investor’s Business Daily, Scott S. Powell, a senior fellow at the Discovery Institute in Seattle, wrote “the DOJ suit serves to blackmail Moody's and Fitch—inhibiting them from proceeding on official downgrades on U.S. government debt and thereby saving Barack Obama from the historical ignominy of the president who lost America's AAA rating.”

‘S&P Was Far From Alone’

“The lawsuit is basically charging that S&P deceived the very banks who created the securities into believing these instruments were of high quality. It raises serious First Amendment concerns to sue for faulty predictions, and S&P was far from alone in making these predictions,” said Berlau.

“Not only did the other credit rating agencies, who haven't been sued, say the same things, but so did government officials from Federal Reserve Chairman Ben Bernanke to House Financial Services Committee Chairman Barney Frank,” Berlau added. “And the biggest hypocrisy of all is that the government still mandates that many financial institutions use credit ratings to meet capital requirements. It was the government that gave rating agencies this special status through these regulatory requirements.”

‘Reflected Best Judgments’

In a statement, S&P said, “Claims that we deliberately kept ratings high when we knew they should be lower are simply not true. . . . At all times, our ratings reflected our current best judgments about RMBS [residential mortgage-backed securities] and the CDOs [collateralized debt obligations] in question. Unfortunately, S&P, like everyone else, did not predict the speed and severity of the coming crisis and how credit quality would ultimately be affected.

"Although we deeply regret that these 2007 CDO ratings did not perform as expected, 20/20 hindsight is no basis to take legal action against the good-faith opinions of professionals. The fact is that S&P's ratings were based on the same subprime mortgage data available to the rest of the market—including U.S. Government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained. Every CDO cited by the DOJ also independently received the same rating from another rating agency.”

Wants $5 Billion, Admission

The Justice Department reportedly is seeking $5 billion in penalties and an admission of wrongdoing. Such an admission could open the firm to further lawsuits.

The government’s lawsuit alleges S&P from September 2004 through October 2007 "knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors” in collateralized debt obligations and securities backed by residential mortgages, many of them subprime.

S&P’s "desire for increased revenue and market share" led it to "downplay and disregard the true extent of the credit risks," the suit alleges.

In a press statement, S&P argued “DOJ is making the absurd contention that Citibank and Bank of America were harmed by S&P’s ratings on CDOs that they themselves arranged and purchased. The DOJ is seeking penalties from S&P for losses allegedly incurred by Citibank and Bank of America on CDOs where the banks played both sides of the transaction.”

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)