NC joins US in suing S&P over pre-crisis mortgage ratings

Posted February 5, 2013

— The U.S. government and several states, including North Carolina, are accusing the debt rating agency Standard & Poor's of fraud for giving high ratings to risky mortgage bonds that helped bring about the financial crisis.

The federal government filed a civil complaint late Monday against S&P, the first enforcement action the government has taken against a major rating agency related to the financial crisis.

North Carolina Attorney General Roy Cooper filed a similar suit Tuesday in Wake County Superior Court. Attorneys general in Arizona, Arkansas, California, Colorado, Delaware, the District of Columbia, Idaho, Iowa, Maine, Missouri, Pennsylvania, Tennessee and Washington also filed their own suits.

S&P, a unit of New York-based McGraw-Hill Cos., has denied wrongdoing. It says the government also failed to predict the sub-prime mortgage crisis.

But the government's lawsuit paints a picture of a company that misled investors knowingly, more concerned about making money than about accurate ratings. It says S&P delayed updating its ratings models, rushed through the ratings process and was fully aware that the sub-prime market was flailing even as it gave high marks to investments made of sub-prime mortgages. In 2007, one analyst forwarded a video of himself singing and dancing to a tune about the deterioration of the sub-prime market, with colleagues laughing.

Ratings agencies like S&P are a key part of the financial crisis narrative. When banks and other financial firms wanted to package mortgages into securities and sell them to investors, they would come to a ratings agency to get a rating for the security. Many securities made of risky sub-prime mortgages got high ratings, giving even the more conservative investors, like pension funds, the confidence to buy them. Those investors suffered huge losses when housing prices plunged and many borrowers defaulted on their mortgage payments.

This arrangement has a major conflict of interest, the government's lawsuit says. The firms that issued the securities could shop around for whichever ratings agency would give them the best rating. So the agencies could give high ratings just to get business.

“Investors thought they were getting objective information, but they got misled, and our entire economy paid a heavy price,” Cooper said in a statement. “These misrepresentations played a major role in creating the national financial crisis, and they must be prevented from happening again.”

The federal lawsuit says that "S&P's desire for increased revenue and market share ... led S&P to downplay and disregard the true extent of the credit risks" posed by the investments it was rating.

For example, S&P typically charged $150,000 for rating a subprime mortgage-backed security, and $750,000 for certain types of other securities. If S&P lost the business — for example, if the firm that planned to sell the security decided it could get a better rating from Fitch or Moody's — then an S&P analyst would have to submit a "lost deal" memo explaining why he or she lost the business.

That created sloppy ratings, the government said.

"Most rating committees took less than 15 minutes to complete," the government said in its lawsuit, describing the process where an S&P analyst would present a rating for review. "Numerous rating committees were conducted simultaneously in the same conference room."

According to the lawsuit, S&P was constantly trying to keep the financial firms — its clients — happy.

A 2007 PowerPoint presentation on its ratings model said that being "business friendly" was a central component, according to the government.

In a 2004 document, executives said they would poll investors as part of the process for choosing a rating.

"Are you implying that we might actually reject or stifle 'superior analytics' for market considerations?" one executive wrote back. "...What is 'market perspective'? Does this mean we are to review our proposed criteria changes with investors, issuers and investment bankers? ... (W)e NEVER poll them as to content or acceptability!"

The lawsuit says this executive's concerns were ignored.

A 2004 memo said that "concerns with the objectivity, integrity, or validity" of ratings criteria should be communicated in person rather than through email.

Also that year, an analyst complained that S&P had lost a deal because its criteria for a rating was stricter than Moody's. "We need to address this now in preparation for the future deals," the analyst wrote.

By 2006, S&P was well aware that the subprime mortgage market was collapsing, the government said, even though S&P didn't issue a mass downgrade of subprime-backed securities until 2007. One document describing the performance of the subprime loans backing some investments "was so bad that analysts initially thought the data contained typographical errors," the government lawsuit said.

In March 2007, one analyst who had conducted a risk ranking analysis of 2006 mortgage-backed securities wrote a version of "Burning Down the House": "Going - all the way down, with/Subprime mortgages."

A video showed him singing and dancing another verse in front of S&P colleagues, who laughed.

Another analyst wrote in a 2007 email, referring to ratings for mortgage-backed investments: "The fact is, there was a lot of internal pressure in S&P to downgrade lots of deals earlier on before this thing started blowing up. But the leadership was concerned of p(asterisk)ssing of too many clients and jumping the gun ahead of Fitch and Moody's."

The government filed its lawsuit in U.S. District Court in Los Angeles. The government charged S&P under a law aimed at making sure banks invest safely, and said that S&P's alleged fraud made it possible to sell the investments to banks. .

If S&P is eventually found to have committed civil violations, it could face fines and limits on how it does business. The government said in its filing that it's seeking financial penalties.

The action does not involve any criminal allegations. Critics have long complained about the government's failure to bring criminal charges against any major Wall Street players involved in the financial crisis.

Criminal charges would require a higher burden of proof and carry the threat of jail time.


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  • mswayze Feb 5, 2013

    would have been cheaper to have bailed out the homeowners.
    add in the other 29 not taken care of by dodd-frank that were there with glass-steagall and its going to happen some more...

  • FlagWavingFascistCrank Feb 5, 2013

    D.A.R.N. Network* Clarification Squad:

    It AIN'T S&P's fault! It's the LIBERALS and SOCIALISTS and ACORN's fault! I SEEN it on the INTERNET!

    *Delusional Alternate Reality News Network

  • Barely Feb 5, 2013

    This is nothing more than a plot of vengeance against the S&P for downgrading the US bond status. There's plenty of others to blame that haven't even been talked about by the AG.

  • mep Feb 5, 2013

    NC is chomping sour grapes after losing so much of its employee pensions in the stock market.... but that is what you get when you gamble. Perhaps NC should just visit Las Vegas... the odds are sometimes better.

    The securities being sold were backed by Fan and Fred... the full faith of the US govt and taxpayers... and they were sold as such.... S&P is not to blame.

  • Wacky_dood Feb 5, 2013

    "Academic snob, What fraudulent activity? If the banks didn't loan the money they were fined very heavely, The S&P saw this and then reduced the rating of the Government becuase of all the bad loans. That is what this administration is upset about. The lower rating is on their watch. and they did nothing to stop it.

    The DOJ is after S&P for knowingly giving fraudulently high ratings to mortgage-backed securities--ratings they knew didn't accurately reflect the risk. State pension funds, among others, are not allowed to "junk" securities. Based on the fraudulent ratings, they duped into buying these securities. When the securities blew up (as the fraudsters knew they would) they lost a lot of money.

    Banks make risky loans all the time. As long as they appropriately disclose the risk, there's no fraud. These guys hid the risks.

    Mortgage-backed securities have nothing to do with why S&P reduced the credit rating of US-issued debt. It had to do with debt/GDP ratio.

  • Milkman Feb 5, 2013

    Babedan - The fraudulent activity was giving high marks to real estate bonds that had little or no chance of performing well due to the borrowers ability to repay. Yes, the institutions had to make the bad loans IF they could find someone to underwrite them. The fraud was giving the loans high marks so they could be underwritten. I'm happy that S&P is going to have to face the music on this, but they're no where close to the only ones, and some of the decisions involved aren't just civil actions, they are criminal. And Academicsnob, the Obama mentions in here are because his Justice Department has done very, very little to bring these guys to justice, either criminal or civil.

  • SouthernPackerFan Feb 5, 2013

    So the other 2 credit ratings organizations had the same exact ratings on these financial institutions but ONLY the S&P downgraded the Obama economy. This is political retaliation at its disgusting worst. Everyone should be enraged!!

    oh ........that's comming!

  • SouthernPackerFan Feb 5, 2013

    so what is so different here from the fed. government (Dodd/Frank) and others who all but forced banks/other mortgage lenders to give loans to people they knew could never pay it back?

    nobody forced anyone to lie, steal and cheat......they own that all on their own!

  • OpenM1nd Feb 5, 2013

    The government is probably also seeking revenge for having its own S&P rating downgraded the last time the debt ceiling got raised. While some of the blame might be S&P's, there are more culprits lurking elsewhere who should also be addressed. Partial scapegoating here.

  • Bill Brasky Feb 5, 2013

    "so what is so different here from the fed. government (Dodd/Frank) and others who all but forced banks/other mortgage lenders to give loans to people they knew could never pay it back?"

    Perhaps because no one forced banks to make bad loans..But due to the deregulated market these poor government abused banks made millions in the 1990s and early 2000s selling their bad loans on the stock market as mortgage backed securities with the possible help of the S&P