Inside Financial Services

The Government’s Nutty Suit Against S&P

The agency didn't commit fraud. It committed stupidity.

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If I’m getting this right, the Department of Justice is suing Standard & Poor’s for failing to foretell the future correctly. If that’s so, heaven help us all; the only one safe from Eric Holder now is Kreskin.

This lawsuit by the government is preposterous. You’ll get no argument from me that the rating agencies (all of them; not just the one the Justice Department singled out) were key players in bringing on the housing debacle and ensuing credit crunch. If the agencies hadn’t slapped triple-A ratings on all those misbegotten portfolios of subprime paper the investment banks kept churning out, no one would have bought them. A huge spigot of cash that ended up flooding into the housing market would have thus stayed shut. We now know that would have been a very good thing.

But S&P committed fraud? No. It is one thing for the agencies to have failed to see the housing bust coming. Lots of people missed it, including (ahem) the people who ran the O.C.C., the F.D.I.C., the S.E.C., and the Fed. The DoJ alleges, though, that S&P didn’t just miss the bus, but rather “knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors in” securities back by subprime mortgage loans. I have a simpler explanation for what happened. “Never attribute to malice that which is adequately explained by stupidity,” goes the old saying. That piece of wisdom was never more apt than here. The people at the rating agencies weren’t crooks. They were fools. They really believed their fancy computer models could accurately predict how a one-in-a-lifetime asset bubble would play itself out once the popping occurred. It turns out they were wrong.

Nor are the supposedly incriminating internal S&P e-mails the government trotted out in its filing, about “bringing down the house” and “ridiculous” deals, as incriminating as we’re supposed to think. All the e-mails show is that honest, vigorous debate really was going on within the agency regarding the securities’ creditworthiness. That’s the way the process is supposed to work. That’s no evidence of conspiracy and fraud. It’s just the opposite.

One last thing: the fact that S&P, the only agency that’s downgraded Treasury debt, is the only agency being sued creates a distinct impression that politics played a role in the Justice Department’s decision. No one argues that S&P’s basic method for rating these deals was any different from the other rating agencies’. If what S&P did was so bad, let DoJ sue the other agencies, too! But it didn’t. This doesn’t looks like justice to me.

What do you think? Let me know!

20 Responses to “The Government’s Nutty Suit Against S&P”

  1. Anonymous

    It’s also about time to downgrade the government again if it can’t get a handle on the budget.. This could get expensive if it still owes a lot of interest. A shot across the bow for all to see perhaps? Guilty dog barking loudest? Got enough minorities in all price ranges whether they can afford it or not now?
    As political science Ex #2 used to say..What we do not have here is a justice system. What we do have here is a legal system. que sera sera

  2. Anonymous

    S&P = Stupid and pathetic. Also very corrupt. This is long overdue.
    PS. Haven’t heard you pump First Marblehead for a while. What’s your take now?

  3. Ken Greenberg

    True the rating agencies were asleep at the switch, but didn’t the Federal government require banks to hold AAA paper from just three favored rating agencies? Did one politician in DC lose a job over this? Or get sued? Oh, I forgot, they’re exempt from that. Didn’t Barney Frank contribute to the debacle by insisting there was no problem at the GSEs? When that was idiotic, didn’t Barney get to write the (2,700 page) Dodd-Frank “fix?” DC is a sad, crony capitalism corrupt joke. Holder is still in office after fast and furious and The “voter suppression” debacle. How does that work?

    S&P is a sad scapegoat. To my knowledge, at no time has the government pulled it’s business or endorsement from any of the rating agencies. This is another effort to deflect blame and culpability away from Congress and the White House. They’re great at that. Congress is like the Roach Motel: they go in, but they never come out. Need term limits!

  4. oy

    I see where David Einhorn is predicting that CDO investors are poised to follow the govt’s lead and sue S&P. Then again he’s been shorting the rating agencies.

    From what I’ve seen S&P wasn’t just stupid, they were wilfully “ignorant”. Stupidity isn’t actionable (although it ought to get someone fired), wilful ignorance, on the other hand, is a whole different matter.

  5. rivvir

    Perhaps, but how do you explain away: “The suit cited internal communications in which S&P considered the need to update its analytic models to keep up with the securities in the changing market, only to continue with the weaker models that permitted higher ratings to go through.

    S&P’s modus operandi was to “limit, adjust and delay those updates” to favor issuers and “maintain and grow S&P’s market share and profits,” the complaint alleges.

    S&P staff debated how many securities to downgrade as more of the loans came up delinquent and the housing market began to sink.

    As the troubles became more widely apparent, one S&P analyst likened the situation to “Burning Down the House” in an email, satirizing the market problems with mock lyrics of the famous Talking Heads song.

    “Strong market is now much weaker. Subprime is boi-ling o-ver. Bringing down the house.”

    But at the same time, S&P continued to rate new CDOs “without making adjustments to account for continuing deterioration” in the investments, the complaint alleges.

  6. PureDakota

    You may be correct, Tom, but I don’t believe we have enough facts to agree with you. It is no defense to say everyone was just as bad, or just as stupid–as they indeed were. We will have to see what S&P itself did. S&P may not have been as stupid as you suggest. All the money they were being paid may have just caused them to lose sight of their job–that many stupid investors would be relying on them, and that S&P itself was perhaps the most critical link in the chain. It will not be an easy case to prosecute, but the defense won’t be a walk in the park either.

  7. PureDakota

    You may be correct, Tom, but I don’t believe we have enough facts to agree with you. It is no defense to say everyone was just as bad, or just as stupid–as they indeed were. We will have to see what S&P itself did. S&P may not have been as stupid as you suggest. All the money they were being paid may have just caused them to lose sight of their job–that many stupid investors would be relying on them, and that S&P itself was perhaps the most critical link in the chain. It will not be an easy case to prosecute, but the defense won’t be a walk in the park either.

  8. Milkweed

    Just a thought but shouldn’t the Einsteins who spent billions on subprime MBS be held to account? Who cares what the ratings agencies said; don’t you have a fuduciary responsibility to know WTF you’re buying when you are in charge of billions of dollars in investments? The ratings agencies certainly deserve their share of blame but IMO the most culpable group in the sub-prime crisis are the mental midgets who couldn’t buy enough sub-prime paper. Take away the buyers and there is no sub-prime crisis. Instead of taking their fair share of blame they’re out suing the banks to pawn their stupidity off on them. Did they really not know that people lied to get LIAR loans? How about someone shining a light on these cockroaches.

  9. DSB

    Agreed. Do a compare and contrast on the supposed smoking gun emails from S&P released by the DOJ and the RBS, UBS and Barclays emails trotted out on LIBOR. No comparison. I do disagree about the notion it is “politics” though. Looks evil to me. Asymmetric prosecution for whatever reason looks like grounds for impeaching Holder.

  10. Chris

    Tom, power is a drug and DoJ is addicted. It’s a shame when there are real issues for them to pursue.

  11. PSG

    Tom, I must humbly disaree. When was the last time you watched a bank stock skyrocket to it’s highest prices ever, with significant fundimental downside potential — and piranha-like swarm mentality driving it up — and still keep it in your portfolio or rate it a “Strong Buy”? You would be asleep at the wheel. To me the Buck Stops with th Rating Agencies and to Rate this “AAA” , not AA+ or sometiing lesser that would offer a hint of possible downside is unjust.

  12. FAS

    I disagree on one point and add on another.

    The rating agencies knew exactly what they were doing based on reading the legal disclaimers in several prospectesus. The ones I read said basically that, “The ratings were based on information furnished by the issuer and no independent researech was done! ” Quite a few analysts left rather than put their names on the deals.
    I agree on the government was the problem. If FNMA and FREDDIE – loaded with Clinton people had not blessed then and Barney and Pete pushed them to buy, then Greenspan and Bernake disasterous policies would not have been able to creat as large a bubble.
    It is definitely a shot across the bow to try to avoid another deserved downgrade.
    Bottom line holder (he doesn’t deserve a title). should be sueing the government!

  13. FAS

    I disagree on one point and add on another.

    The rating agencies knew exactly what they were doing based on reading the legal disclaimers in several prospectesus. The ones I read said basically that, “The ratings were based on information furnished by the issuer and no independent researech was done! ” Quite a few analysts left rather than put their names on the deals.
    I agree on the government was the problem. If FNMA and FREDDIE – loaded with Clinton people had not blessed then and Barney and Pete pushed them to buy, then Greenspan and Bernake disasterous policies would not have been able to creat as large a bubble.
    It is definitely a shot across the bow to try to avoid another deserved downgrade.
    Bottom line holder (he doesn’t deserve a title). should be sueing the government!

  14. jimmymac

    I agree with you and wonder why there is no outrage about the actions of HUD, FHA, Barney Frank, Dodd, Freddie or FAnnie. Oh I forgot there is no accountability in the government sector. While I’m at it how come the President can Auto sign legislation, but when banks robo-sign foreclosures is a crime.

  15. jimmymac

    I agree with you and wonder why there is no outrage about the actions of HUD, FHA, Barney Frank, Dodd, Freddie or FAnnie. Oh I forgot there is no accountability in the government sector. While I’m at it how come the President can Auto sign legislation, but when banks robo-sign foreclosures is a crime.

  16. terry

    surely you don’t expect government to man up to its part of the problem, do you?

  17. Walter Wriston

    What’s the first rule of investing? Trust no one. Those of us who are professional investors always knew that S&P, Moody’s, Fitch, DLJ, Goldman, Alex. Brown, Merrill, Fidelity, T. Rowe and the rest were incompetent (at best) or flat-out crooked. People who trusted S&P or DLJ were guilty of stupidity.

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