Is S & P on the Government’s Hit List?
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By Sterling Wong,
Money Watch
February 6, 2013

Late Monday, the US Justice Department filed a $5 billion civil lawsuit against credit rating agency Standard & Poor’s (NYSE:MHP), claiming that the group sought to defraud investors by inflating its mortgage securities ratings prior to the financial crisis, thus making them appear safer than they were.
 
The lawsuit marked the first federal enforcement action against a rating agency over the financial crisis.
 
Responding to the government’s allegations, S&P said in a statement that “A DoJ lawsuit would be entirely without factual or legal merit.”
 
The rating agency also signaled that it was being unfairly singled out by the government, saying that “every CDO [collateralized debt obligation] that DoJ has cited to us also independently received the same rating from another rating agency.”
 
Indeed, it is thus far unclear why it is that the government is suing only S&P, and not Moody’s (NYSE:MCO) or Fitch, the two other major credit rating agencies that have also been heavily criticized for assigning artificially high ratings to subprime and other mortgage securities that ultimately collapsed.

The omission of other rating agencies in the lawsuit is especially striking when one looks at the evidence the Justice Department cites against S&P, adds Matt Levine of the financial commentary site Dealbreaker. The government’s 119-page lawsuit references numerous internal S&P emails in which employees questioned the way mortgage securities were rated.
 
For example, one incriminating email the Justice Department cited read:
We just lost a huge Mizuho RMBS deal to Moody’s due to a huge difference in the required credit support level. What we found from the arranger was that our support level was at least 10% higher than Moody’s. Losing one or even several deals due to criteria issues, but this is so significant that it could have an impact on future deals.
 
Looking at the content in this particular email, Levine points out that “S&P seems to have done most of its shady things not to be more aggressive than Moody’s, but just to get to level with Moody’s… According to the DoJ complaint itself, S&P were just joining the race to the bottom, not starting it. S&P’s alleged billion-dollar-plus fraud consisted basically of moving its ratings so they were more in line with Moody’s. Moody’s, you’ll note, has not been sued.”  [emphasis in original]
 
What, then, could explain the government’s singling out of S&P? Some commentators are alleging that it’s because S&P had the temerity to have downgraded US federal debt last year after the debt ceiling debacle.
 
An anonymous source familiar with the Justice Department’s investigation of ratings agencies told McClatchy, for example, that the department’s initial probe, launched three years ago, had involved both S&P and Moody’s. However, “investigator interest in Moody's apparently dropped off around the summer of 2011, about the same time S&P issued the historic downgrade of the US government's creditworthiness because of mounting debt and deficits,” reported McClatchy.
 
"Why not Moody's and Fitch? Are they innocent of similar things? Why S&P? Because they downgraded the United States. The fact that this targeted one rating agency when all three are equally guilty is suspicious, (needs) to be explained and leads me to believe that this is a politically motivated lawsuit. Yes, there is wrongdoing, but not everybody who speeds on the highway gets stopped by the cops,” Sylvain Raynes, a former Moody’s employee, told McClatchy.
 
At Fox News, University of Maryland professor Peter Morici also opined that the Obama administration “appear[s] to be engaging in political vengeance.” He wrote that given the US’s tenuous fiscal situation, “by not downgrading US debt, Moody’s and Fitch have demonstrated the same neglect to investors that all three bond rating agencies practiced during the mid-2000s—now, the Justice Department lets them pass by targeting S&P.”

Personal finance columnist John Crudele offered a similar argument at the New York Post. Crudele observed that “there’s no indication that Moody’s was any better at spotting the crappy mortgages that were bundled into securities by Wall Street and later sold (or taken over) by the government and taxpayers.”
 
Given that S&P has warned that it could further lower the US’s credit rating this year, “is the US taking the offensive against S&P to keep the ratings firm in line at a crucial time in the discussions between Republicans and Democrats over how to handle the nation’s debt ceiling and profligate spending ?” Crudele questioned.
 
When Minyanville asked Aswath Damodaran, a finance professor at the Stern School of Business at New York University, if he thought S&P was being unfairly singled out by the Obama administration, Damodaran declined to comment on the case, but he said in an email reply that the entire saga “is a tempest in a teapot.”
 
“The ratings agencies are guilty of many things but I don't think one of them is fraud,” said Damodaran.
 
While S&P is the only rating agency that has been sued so far, it is also possible that this is merely the Justice Department’s opening salvo, and that if the government wins, further lawsuits could come, Robert Piliero, a lawyer at Butzel Long in New York who has worked on structured-finance litigation, told Bloomberg.
 
Jeffrey Manns, a law professor at George Washington University, concurred, telling CNBC, "This lawsuit is significant because it could augur future government action or, even worse for the agencies, more litigation by investors.”
 
And even if the government does not end up going after Moody’s or Fitch, Manns said that “filing a high-profile lawsuit against S&P tells the rating industry at large that the government is serious about holding rating agencies responsible, and that they must be much more careful.”
 
Moody’s has certainly felt the impact of the Justice Department’s legal action at the markets, if not at the courtroom. In the first two days of the week, the stock plunged $10.26, its largest two-day decline in nearly four years, to close at $45.09 on Tuesday. S&P’s parent company, McGraw-Hill, meanwhile, has also seen its shares tumble more than 20% since news of the lawsuit broke.

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