It has been more than five years since those steaming piles of toxic, subprime mortgages were scooped up, cut up and then “structured” into the bundles of seemingly sanitized investment vehicles.
Of course, they weren’t sanitary at all. Combined, they almost took down the world’s economy after they turned out to be exactly what, in fact, they were — waste matter.
Never mind that analysts at Standard and Poor’s, one of the country’s largest and most influential securities rating agencies, deemed all those foul-smelling instruments to be sweet-smelling bouquets. Now, though, S&P is getting its own sniff test.
U.S. Attorney General Eric Holder, along with attorney generals from 16 states, accused S&P and its parent, the McGraw-Hill Companies, of fraud. The reason: for intentionally propping up the ratings of shaky mortgage investments to increase its own profits and to prevent clients from going elsewhere to get better ratings for their sets of structured nastiness.
The lawsuit accuses S&P of making false representations, concealing facts and manipulating ratings criteria and credit models. It seeks $5 billion dollars in penalties as punishment for the inflated credit ratings that Holder called “egregious” and central to the worst economic crisis since the Great Depression.
“We rate every deal. It could be structured by cows and we would rate it.”
— From an email written by a Standard and Poor’s employee
Illinois Attorney General, Lisa Madigan, who sued S&P more a year ago, added: “Standard and Poor’s was a trigger for the destruction of our economy. While the big banks and lenders built mortgage-backed bombs, it was S&P’s faulty ratings that detonated them.”
Ratings Game is Rigged
Between September 2004 and October 2007, S&P rated more than $2.8 trillion worth of residential mortgage-backed securities (MBSs) and about $1.2 trillion worth of collateralized debt obligations (CDOs). Along with its two main competitors, Moody’s Investors Service and Fitch Ratings, the three agencies routinely downplayed the risks inherent in these complex securities in order to gain more business from the investment banks that issued them.
And, in a sense, who can blame them?
The business model is a classic conflict-of-interest bogeyman that creates every incentive to play fast and loose with the numbers, because the agencies are paid by the very banks that create the investments they’re rating.
And at $150,000 a pop for rating a subprime mortgage-backed security and up to $750,000 for certain other securities, S&P executives simply couldn’t afford to lose business to the other two firms — even at the risk of giving up any shred of integrity in an industry that ostensibly relies on high standards of objectivity, independence and truthfulness for its very existence.
But according to acting Associate Attorney General Tony West, the company would “regularly tweak, bend, delay updating, or otherwise adjust its ratings models to suit the company’s business needs.”
S&P Claims Innocence
S&P’s defense? The First Amendment. That’s right. S&P maintains that the firm’s ratings are merely “predictive opinions” which, much like the musings of journalists, are protected by constitutional guarantees of free speech.
Absent specific intent to defraud, it says, it cannot be held liable for the results those opinions may engender.
In other words, S&P is much like a theater critic who gives a good review to a bad show. If audiences believe the review and go to see the show in droves but then ultimately decide it’s a stinker and a waste of the ticket price, well, it’s not the critic’s fault. After all, everyone is entitled to his own opinion.
In previous court cases, S&P, Moody’s and Fitch all played the free speech card successfully. Lawsuits against the companies for fraud routinely were thrown out.
But that tide may be turning. In November, a circuit court judge in Cook County, Illinois, rejected arguments that ratings firms’ opinions were protected free speech. And some constitutional scholars maintain that the First Amendment doesn’t extend to the deliberate manipulation of financial markets.
Former U.S. Senator Ted Kaufman, who investigated the financial crisis agrees, “If you’re selling something that you’re saying has a certain level of safety, and you know it doesn’t have that level of safety, that’s fraud.”
The Justice Department Slaps Wrists
In any case, the Justice Department, whose critics have maintained is way too reluctant to persecute financial firms responsible for the crisis that cost millions of Americans their homes and jobs, believes that this time it has solid evidence that S&P knew exactly what it was doing and why.
Unfortunately for those who want to see a few well-coiffed heads on sticks planted on Wall Street, the Justice Department won’t seek any criminal indictments that would lead to jail time for actions perpetrated by S&P higher-ups. In charging S&P executives in a civil case under provisions of the Financial Institutions Reform, Recovery and Enforcement Act, a statute adopted in 1989 during the savings and loan crisis, the government can only recoup money that it expended bailing out failed financial institutions.
So once again, even if the suit is successful, a lot more people will be walking away from the mess they helped to create.
And that might be the biggest crime of all.