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S&P Under Fire
Posted By Arnold Ahlert On August 19, 2011 @ 12:35 am In Daily Mailer,FrontPage | 12 Comments
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.”
Yet it is precisely that mispricing of risk, and a concerted effort to rehabilitate its reputation , that likely compelled S&P to downgrade America’s debt. Whether that effort caused them to overreact in the other direction becomes the ultimate — and ultimately political — question.
Bob Litan, deputy assistant attorney general at the Department of Justice from 1993 to 1995, waded into the political morass, addressing the suspicion by more than a few Americans that the investigation was payback for the downgrade. “Having been at the Justice Department, I don’t think the department behaves that way. I think this is almost certainly a coincidence. It’s just the way these things happen,” Litan told ABC News. He also believes the investigation isn’t limited to S&P. “My guess is that if the Justice Department is investigating one agency, it’s investigating them all,” he said. “Given what we all know now in the run-up to the financial crisis, all the ratings agencies were doing similar things in rating these securities. If S&P is guilty of something I find it hard to believe the others wouldn’t be too.”
This has been the most compelling aspect of the story. If S&P is being singled out, it would be an obscene breach of ethics on the part of the administration. One would think the DOJ would make it clear one way or the other as soon as possible. But an overlooked aspect of the story is the possible conflict of interest regarding any ratings agency investigation. In the years leading up to the housing crisis, and continuing through to the present, it was the DOJ which forced banks to make questionable mortgages available to less-than-qualified applicants. As of May, more than 60 banks were under investigation  by the DOJ for “lending discrimination,” and a Fair Lending Unit staffed with more than 20 lawyers, economists and statisticians, was created for the very first time, to facilitate investigations.
Thus, a logical question arises: if banks have been pressured to make questionable loans, is it possible that the Justice Department, if not pressuring the ratings agencies, was at the very least inclined to look the other way when those bundled mortgages were highly rated?
We may never know, as least as far as the SEC is concerned. On Wednesday, Rolling Stone Magazine reported  that the SEC “devised an elaborate and possibly illegal system under which staffers were directed to dispose of the documents from any preliminary inquiry that did not receive approval from senior staff to become a full-blown, formal investigation.” The destroyed files included a “2002 inquiry into financial fraud at Lehman Brothers,” a “2009 preliminary investigation of insider trading by Goldman Sachs” and “records for at least three cases involving the infamous hedge fund SAC Capital,” according to “a whistle-blower at the SEC who recently came forward to Congress.”
As for the Justice Department, it, too, is embroiled in a high degree of questionable behavior, from its dropping  of the voter intimidation case against members of the New Black Panthers in Philadelphia during the 2008 election, to the current stonewalling  of the investigation into the Mexican gunwalking scandal known as “Fast and Furious.”
None of this excuses any impropriety in which S&P or the other ratings agencies may have been engaged. As the Times points out, these agencies were paid $100,000 to rate mortgage bond deals, and “several hundreds of thousands of dollars more for rating the far more complex collateralized debt obligations ” (CDOs) which contributed mightily to the financial crisis of 2008. Yet it was the banks themselves who shopped around for agencies willing to give them good credit ratings in exchange for the banks’ business. And it was the DOJ who pressured the banks to make questionable loans.
Thus, the ultimate question arises: where’s an independent special prosecutor when America desperately needs one?
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URLs in this post:
 Image: http://frontpagemag.com/wp-content/uploads/2011/08/gty_standard_poors_ll_110818_wg.gif
 reporting: http://www.nytimes.com/2011/08/18/business/us-inquiry-said-to-focus-on-s-p-ratings.html?_r=1&hp
 $2 trillion accounting error.: http://news.yahoo.com/treasury-2-trillion-man-020900153.html
 inability to find $4 trillion in deficit reduction: http://online.wsj.com/article/SB10001424053111903366504576490841235575386.html
 pristine.: http://finance.fortune.cnn.com/2011/08/06/u-s-downgrade-standard-poors/
 Enron: http://www.chron.com/news/specials/enron/
 ease: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ax3vfya_Vtdo
 does not : http://consumerist.com/2011/08/justice-department-investigates-standard-poors-mortgage-security-ratings.html
 target: http://abcnews.go.com/Business/standard-poors-justice-department-reportedly-investigates-credit-rating/story?id=14332010
 rehabilitate its reputation: http://www.independent.co.uk/news/business/news/sampp-fights-to-save-reputation-as-markets-hold-their-breath-2333626.html
 under investigation: http://www.investors.com/NewsAndAnalysis/Article.aspx?id=572091
 reported: http://www.rollingstone.com/politics/news/is-the-sec-covering-up-wall-street-crimes-20110817
 dropping: http://www.washingtontimes.com/news/2009/may/29/career-lawyers-overruled-on-voting-case/?feat=home_cube_position1
 stonewalling: http://frontpagemag.com/2011/07/08/melson-wont-take-the-fall-for-fast-and-furious/
 collateralized debt obligations: http://topics.nytimes.com/topics/reference/timestopics/subjects/c/collateralized-debt-obligations/index.html?inline=nyt-classifier
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