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S&P Lawsuit Raises Questions About Feds’ Motivations

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What happens if you’re endorsed by one federal agency and punished by another?

That’s one question to arise from the lawsuit filed by the Justice Department on Tuesday that seeks 5$ billion in penalties from ratings firm Standard and Poor’s and its parent McGraw-Hill.

Calling the conduct “egregious,” Attorney General Eric Holder alleged fraud in his announcement of the suit, and that S&P improperly inflated credit ratings, which are seen as a major contributor to the financial crisis of 2008.

Despite the actions by Holder and the Justice Department, the S&P is still one of only three ratings agencies approved by the SEC (Fitch and Moody’s being the others). The Dodd-Frank regulatory reform act addressed the oligopolistic powers granted the three firms, but two years after its passage wider competition in the space has yet to happen.

Critics of the suit contend that applications by independent ratings firms for government-approved status continue to languish in bureaucratic red tape, further insulating the three firms in their positions.

Questions are also being raised as to why only S&P is targeted in the suit, since it could be said that Fitch and Moody’s assigned inflated ratings as well.

“We’ve long argued that the government should not endorse any company’s opinions about credit risk, which at the end of the day is all a credit rating is—an opinion,” The Wall Street Journal argues in an editorial on Wednesday. “And for that reason the government will not have an easy time making a fraud case.”

The paper also raises the question of whether or not the action is politically motivated payback for S&P’s downgrade of government debt last summer to AA+ from AAA.

“There are other disturbing questions related to the timing and the target of this federal civil prosecution,” the Journal writes.

S&P’s attorney Floyd Abrams told the papers that “things seemed to rev up in terms of the intensity” of the federal investigation after S&P’s historic downgrade of U.S. credit following Washington’s debt-limit fight.

Meanwhile, the Journal points to a McClatchy Newspapers report that says “it was around that time that Moody’s, which did not downgrade the government, was dropped from the federal investigation. Ask any investor and he’ll likely tell you that Moody’s was equally awful in forecasting the mortgage debacle.”

S&P, for its part, denies the government allegations, calling the claims that it deliberately kept ratings high when it knew they should be lower are “simply not true” and that they will “vigorously” defend themselves against these “unwarranted claims.”

“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 company argues. “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.”