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In what is being characterized as nothing more than a confluence of events, The New York Times is reporting that the U.S. Department of Justice (DOJ) is conducting an investigation of the Standard & Poor’s ratings agency. The investigation ostensibly pre-dates S&P’s lowering of the country’s credit rating from AAA to AA+, a move which engendered a firestorm of criticism, highlighted by the Treasury Department’s contention that the downgrade was the result of a $2 trillion accounting error. S&P acknowledged the error, but downgraded America’s credit rating anyway, citing Washington’s inability to find $4 trillion in deficit reduction over ten years as the primary reason for the change.
The focus of the DOJ’s investigation is directly tied to the housing boom years, when S&P and other ratings agencies amassed record profits based largely on the sheer volume of loans being written. The inquiry specifically centers around whether or not company analysts, who reportedly wanted to award lower ratings on mortgage bonds, were overruled by other S&P managers. If such is the case, it would undermine S&P’s long-standing claim that it is an independent operator immune from the influence of the entities it is hired to rate.
There is no question that S&P’s track record was far from pristine. It completely missed the Enron debacle when that company went bankrupt due to accounting irregularities and criminal management. Banking giant Bear Stearns didn’t get downgraded until the day it declared bankruptcy. And S&P completely missed the 2008 housing meltdown, which was caused in large part by a move in 2004, first by Moody’s and then by S&P, to ease credit rating formulas for securities backed by commercial properties due to the threat of “losing deals.” From 2002-2007 Wall Street underwrote $3.2 trillion of questionable home loans which were bundled into investment pools that received AAA ratings.
Joseph Stiglitz, a Columbia University professor and 2001 Nobel Prize winner for his analysis of markets with asymmetric information, illuminated the problem back in 2008. “Without these AAA ratings, that would have stopped the flow of money,” he said, further adding that S&P and Moody’s were “trying to please clients.”
Yet according to the Times, it is currently “unclear” whether or not Moody’s or the other major ratings agency, Fitch, are targets of the investigation by the Justice Department. The Securities and Exchange Commission (SEC), which is also looking into possible wrongdoing, “may be looking” at Fitch and Moody’s as well, according to the unnamed person interviewed by the paper.
Both the Justice Department and the SEC refused to comment on whether or not they were conducting investigations, which is the customary procedure. As to the nature of the investigation itself, witnesses interviewed by investigators have been told the government is pursing civil, not criminal charges. It should also be noted that just because an investigation is taking place, that does not mean the DOJ will take action. An S&P spokesman released an email to the Times indicating such a possibility. “S.& P. has received several requests from different government agencies over the last few years. We continue to cooperate with these requests. We do not prevent such agencies from speaking with current or former employees,” it read.
Irrespective of the investigations, S&P remains a target for heavy criticism. The city of Los Angeles has withdrawn its contract with S&P to rate the municipality’s $7 billion investment portfolio, citing the agency’s downgrade of America’s credit rating as the reason. “Quite frankly, we just don’t want to be associated with [Standard & Poor's] anymore based on that decision,” said Thomas Juarez, the city’s chief investment officer and assistant treasurer. “We think it was irresponsible and just excessive.” Rep. Spencer Bachus, (R-AL) was equally critical during a House financial services oversight subcommittee hearing on July 27. “The credit rating agencies failed spectacularly in the years leading up to the financial crisis,” he said. “A government seal of approval for credit rating agencies led to a mispricing of risk and the subsequent collapse in market confidence.”
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