Feds Will Sue Standard and Poors

image_pdfimage_print

The possible penalties of more than $5 billion are equal to the losses suffered by federally insured financial institutions that bought collateralized debt obligations and other securities that were tainted by S&P’s alleged conflicts of interest and other illegal behavior, Mr. Holder said.

S&P and other firms have long fought lawsuits targeting the quality of their ratings by citing the First Amendment to the U.S. Constitution, which protects freedom of speech, and contending that the ratings are an opinion. In its suit, the Justice Department lawsuit tries to get around that argument by dusting off a 1989 law from the savings-and-loan crisis that imposes a relatively lower burden of proof.

In a statement Monday, S&P said the U.S. government’s use of that law, the Financial Institutions Reform, Recovery, and Enforcement Act, is a “questionable legal strategy.” The firm said it would “vigorously defend our Company against such meritless litigation.”

In its statement Tuesday, S&P said its ratings reflected its best judgments about the RMBS and the CDOs in question.

“Unfortunately, S&P, like everyone else, didn’t predict the speed and severity of the coming crisis and how credit quality would ultimately be affected,” it said.

S&P also said “20/20 hindsight is no basis to take legal action against the good-faith opinions of professionals,” noting that its ratings were “based on the same subprime mortgage data available to the rest of the market—including U.S. Government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained.”

[Update 4:00 pm left coast time: I added a new section featuring quotes from Twitter.  Folks over there are having too much fun with this.]

The news broke yesterday (February 4).  The Feds will sue Standard and Poors.  The alleged reason is that S&P rated mortgage-backed securities AAA when in fact they should have been rated much lower.  For details see the excerpt from the Wall Street Journal article over there on the right (no pun intended).

Now there’s no doubt the AAA ratings were too high.  But there are several remaining questions.  First, why is the Justice Department not going after Fitch and Moody’s?  Both also rated these securities well above what they should have been.  Second, many of us are skeptical of the government’s motives in this case. You may recall that S&P was the first agency to downgrade the rating on U.S. government debt (from AAA to AA+).  The announcement of the downgrade was August 5, 2011.  It only makes sense to wait until after the election to file this lawsuit. Third, 20-20 hindsight is always 100 percent accurate.  If it was so easy to see these securities were rated too highly, where were the government regulators?

Stockholders lose $3.8 billion

S&P is being sued for $5 billion.  In the last two days, their parent company, McGraw-Hill, has seen the stock price fall by 23,29% (from $58.34 to $44.75).  The company’s market cap has dropped from $16.2 billion to $12.4 billion, wiping out $3.8 billion in shareholder wealth.  Here’s what that looks like:

McGraw-Hill stock price

McGraw-Hill stock price

(Data is from the Wall Street Journal website accessed February 5, 2013 at 3:45 pm GMT -8.  Click here to download the Excel workbook containing the numbers and calculations.)

Meanwhile On Twitter and In the Blogosphere

In case you think I’m just a conspiracy nut, I am not alone.  A lawyer for S&P refused to rule out a political motivation behind the lawsuit.  And even the Federal Reserve didn’t see the crash coming as the recently-released minutes from their 2007 meetings.  Should Justice also sue the Fed?  The slideshow below shows some of the more entertaining comments from Twitter.

[portfolio_slideshow navpos=top slideheight=100 include=”1539,1538,1537,1536,1535,1534,1533,1532,1531″]

Heidi Moore points out,

This is why singling out RBS, or UBS, or S&P, will never have the fearsome deterrent effect that the DOJ really wants. In fact, by going after the firms piecemeal, the DOJ may actually be encouraging future wrongdoers rather than turning them away from crime.

You see, the DOJ is going after one or two firms for actions that were widespread across the industry. Fixing interest rates was the work of thousands of people. It’s safe to say that S&P was not the only ratings firm that fretted that it would lose fees if it started downgrading bonds. In fact, S&P, according to the emails provided by the DOJ, frequently worried that it was not keeping up with Moody’s.

Conclusion

Someone on Twitter said, “S&P announced U.S. government debt is now rated AAAA+++.”  The next time someone asks you why the U.S. economy is not recovering faster, point to actions like this.  Why take any risk when the government can come in years later and hammer your market value?