Courtesy of Pam Martens.
Late last night, the U.S. Department of Justice filed a civil lawsuit in Los Angeles against the credit rating agency, Standard and Poor’s, over alleged deceptive ratings it gave to debt instruments it rated for large investment banks on Wall Street. The suit charges the deceptive ratings were motivated by a desire to gain more business from the Wall Street firms which pay for the ratings.
Ratings on debt instruments play a pivotal role in helping investors select suitable investments. Ratings of AAA through BBB- are considered investment grade with ratings below that viewed as non-investment grade or junk. And it’s not just individual investors who are impacted by ratings. Banks are legally limited in the amount of non-investment grade securities they can hold and are required to post additional capital when their investment risks rise. When rating agencies assigned AAA ratings to what were effectively junk bonds, banks were able to take on dramatically higher risks without buttressing their capital cushion, leaving them short of capital when the crisis hit.
Standard and Poor’s issued a detailed statement yesterday vowing to fight the lawsuit and outlining the arguments it will use. One argument goes like this:
“We have long had policies in place to manage potential conflicts of interest, including a separation of analytic and commercial activities, a ban on analysts from participating in fee negotiations, and de-linking analyst compensation from the volume of securities they rate or the type of ratings they give out. Post-crisis, we further strengthened analytical independence by rotating the analysts assigned to a particular issuer and enhancing analyst training on issuer interactions.”
That argument is likely to fall on deaf ears if the case goes before a jury. On April 23, 2010, the U.S. Senate’s Permanent Subcommittee on Investigations released 581 pages of exhibits in conjunction with a hearing it held on “Wall Street and the Financial Crisis: The Role of Credit Rating Agencies.” Among the exhibits were 12 excruciatingly incriminating emails from inside Standard and Poor’s. The emails, listed below, showed that worries about losing business if good ratings were not assigned was a perpetual concern inside the company and influenced rating decisions.
Unfortunately, when Congress permits a system where Wall Street gets to “pay to rate,” and can shop around for the rating agency willing to give the highest rating to its deals, it’s preposterously naïve to expect any other outcome other than corruption. One would have thought that the first thing Congress would have done after disclosing its trove of evidence would be to pass legislation to end the ability of the issuer to pay for the rating. But the status quo remains, furthering damping investor confidence in Wall Street, the ratings agencies and Congress.
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