On this episode we catch up with the Department of Justice. The DoJ, after 7+ years has finally decided to go after the ratings agencies. At various points in the history of this recession the banks, insurers, mortgage brokers, Wall Street, Congress, the real estate industry, the Fed, economists, and very likely you have been blamed for this mess. But what has slipped through the eyes of government and the public has been the ratings agencies.

These agencies offer credit ratings on all types of securities out there. Their specialty is in fixed income which can be anything from a mortgage-backed security to a government issued bond. The agencies. Standard & Poor’s, Fitch, and Moody’s, look at the likelihood of whether the security will actually pay back all the money it borrowed and issue a score based on this. Their models are sophisticated but far from perfect. None of them saw the crisis coming and issued perfect credit ratings to securities filled with toxic mortgages.

Back to the DoJ. They have finally decided to go after Standard & Poor’s (S&P) for their role in the crisis. They say that S&P knowingly put top ratings on junk. Why would they do that? Because the banks issuing these securities pay the agencies for the ratings. So if the agency doesn’t offer a good score the bank may take their business elsewhere.

Interestingly, S&P argues the lawsuit is without merit because they didn’t knowingly issue false ratings. Said another way, the S&P is admitting their own gross incompetence. “The Big Short”, a book about the crisis, seems to agree. Wall Streeters portray the agencies as employing a bunch of wanna-be bankers. Bankers routinely outsmarted or otherwise treated the agencies like pushovers.

So that’s the story S&P seems to be running with. The problem is the DoJ seems to have some emails that offer a different perspective on events. S&P knew the banks where their customers. So as early as 2004 they were discussing a way to rate securities based on the way bankers wanted them rated. At least one executive raised their hand about this being a problem, but there were likely ignored.

USA Today has some incriminating quotes from some exchanges between an analyst at S&P and a banker:

  • Banker to Analyst:  “I mean come on, we pay you to rate our deals, and the better the rating the more money we make?!?! Whats [sic] up with that? How are you possibly supposed to be impartial????”
  • Analyst to Banker: “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*ssing off too many clients and jumping the gun ahead of Fitch and Moody’s”

It’s a shame this has taken so long. The agencies may be the last group to bear responsibility that hasn’t already faced it in some degree. We’ll never find true villains here because it was just a collection of millions of people acting in their self interest. But everyone has paid some dues at this point except the agencies. Their time has come.

Read: Holder: S&P lied, investors lost (CBS Money Watch)

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categories: banking, business, government, investing, loans