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MailTribune.com
  • S&P reveals government lawsuit over ratings

    Credit-rating firm faces civil charges by Justice Dept. over ratings of mortgage bonds before financial crisis
  • WASHINGTON — Trying to get ahead of a potentially explosive story, credit rating agency Standard & Poor's announced Monday that the Justice Department had informed the company that it's the target of a civil lawsuit for the AAA ratings it gave to complex bonds in 2007 that later turned out to be junk.
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  • WASHINGTON — Trying to get ahead of a potentially explosive story, credit rating agency Standard & Poor's announced Monday that the Justice Department had informed the company that it's the target of a civil lawsuit for the AAA ratings it gave to complex bonds in 2007 that later turned out to be junk.
    In a highly unusual statement, S&P, a subsidiary of publishing giant The McGraw-Hill Companies Inc., said that the Justice Department would sue the company for failing to predict the full magnitude of the U.S. housing downturn, something Wall Street banks and federal regulators all missed as well.
    Given that S&P issued a historic downgrade of U.S. creditworthiness in August 2011 and has threatened to take that rating down a further notch, the pending suit is raising questions of whether it actually amounts to retaliation.
    At issue are financial instruments called collateralized debt obligations, shorthanded as CDOs — complex bonds, sold to investors in 2007, that pooled together mortgages and other consumer and business debt. Investors bought into differing levels of risk and thus got varying levels of financial return.
    S&P said Monday that it's being unfairly singled out.
    "It would disregard the central facts that S&P reviewed the same subprime mortgage data as 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 — and that every CDO that (the Justice Department) has cited to us also independently received the same rating from another rating agency," the company said.
    Justice Department spokeswoman Adora Andy declined comment. An S&P official said the company was told it would be charged under the Financial Institutions Reform, Recovery and Enforcement Act. That statute dates back to the savings and loan crisis in the late 1980s and early 1990s.
    "This has never been used in conjunction with a rating agency and is unprecedented," Catherine Mathis, S&P's senior vice president of marketing and communications, told McClatchy. "They have used it against some of the banks in the past. Clearly this was not the purpose for which it was intended."
    Ratings agencies historically have enjoyed First Amendment protection under the law, with courts determining that their ratings amount to protected free speech since they reflect opinions about the creditworthiness of an issuer of a bond.
    Reporting by McClatchy, later confirmed in Senate hearings and by the special Financial Crisis Inquiry Commission, found that ratings agencies effectively let their lucrative business for rating complex bonds — a subset called structured finance — erode the quality of ratings.
    Further complicating matters, AAA ratings on government bonds issued by, say, France are based on a long history of past performance, something that didn't exist for complex mortgage bonds that were being offered by giant Wall Street investment banks. The ratings agencies had to invent a methodology to approximate past performance based partly on geography, which turned out to be a poor measure of the chance of a bond's default.
    Among the many questions raised by the pending Justice Department civil suit is why S&P alone is being charged. A person familiar with the department's investigation of ratings agencies said the probe has gone on for three years and originally also involved Moody's Investors Service. A Moody's spokesman did not respond to a request for comment, but Daniel Noonan, a spokesman for Fitch Ratings, the third major rating agency and the only one that is not a publicly traded company, said that "we have no reason to believe Fitch is a target of any such action."
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