S&P, Moody’s Mortgage-Security Ratings Are Said to Face U.S. Investigation

The U.S. Justice Department is probing Moody’s Investors Service and Standard & Poor’s over ratings of mortgage-backed securities, according to three former employees who said they were interviewed by investigators.

Washington-based lawyers from the Justice Department spoke to former employees as recently as last month about whether the companies raised their grades for the complex investments in order to win business, said the former employees, who asked for anonymity because the investigation is ongoing. The inquiry is a civil matter, two of them said.

The probe is the latest of dozens of government investigations and investor lawsuits targeting Moody’s and S&P, a unit of McGraw-Hill Cos., all based in New York, over the top grades they assigned to bonds backed by subprime mortgages. Even as the Financial Crisis Inquiry Commission called them “key enablers of the financial meltdown,” the raters avoided legal liability, according to Benchmark Co.’s Edward Atorino.

“People have been poking around Moody’s and McGraw-Hill forever,” Atorino, a New York-based analyst, said in a telephone interview. “They haven’t found the smoking gun yet.”

The Justice Department has been contacting analysts to discuss mortgage-bond ratings since 2009, the former employees said. In May, Senator Carl Levin, the Michigan Democrat who chairs the Permanent Subcommittee on Investigations, referred the results of a probe into mortgage bonds, credit ratings and the financial crisis to the agency.

‘Dark Clouds’

Terry McGraw, the chief executive officer of S&P’s parent company, said on a July 28 conference call with analysts that 30 lawsuits against the rater have been dismissed or dropped and that he’s seeing “those dark clouds go away.” Judges have ruled that the ratings are opinions, protected by the right to free speech, according to Sean Egan, president of Egan-Jones Ratings Co.

“To date, the freedom of speech defense has worked,” Egan said in a telephone interview. “If there’s evidence that a ratings firm intentionally issued an inflated rating and the effect was to defraud somebody then I think it would be a completely different matter.”

S&P is also being scrutinized by the Securities and Exchange Commission over its decision to strip the U.S. of its top AAA rating on Aug. 5, according to a person with direct knowledge of the matter. Ed Sweeney, a spokesman for S&P, said the firm has “received several requests from different government agencies over the last few years regarding U.S. mortgage-related securities.” S&P has cooperated with the requests, he said.

‘Race to the Bottom’

Michael Adler, a spokesman for Moody’s, declined to comment, as did Charles Miller, a Justice Department spokesman.

S&P, Moody’s and Fitch Ratings engaged in a “race to the bottom” to assign top grades to mortgage-backed securities at the request of the banks that paid them, Levin’s panel said in an April report. The inflated ratings helped fuel the worst financial crisis since the Great Depression, which caused $2.1 trillion in losses and writedowns at the world’s biggest financial institutions, according to data compiled by Bloomberg.

“Maybe a Justice Department investigation will force action on the conflicts of interest problem and accomplish what should have been done a long time ago,” Senator Charles Grassley, an Iowa Republican, said today in a statement. Jill Gerber, a spokeswoman for the senator, said he was commenting on a New York Times report and didn’t have direct knowledge of any probe.

Analysts Pressured?

The Justice Department investigators asked whether S&P executives pressured analysts to change ratings in order to get more business, according to one of the former employees. He said the investigators asked about e-mails released by Levin’s panel, including one in which an S&P manager asked analysts whether criteria for rating collateralized debt obligations could be loosened to avoid losing business to Moody’s.

“We are meeting with your group this week to discuss adjusting criteria for rating CDOs of real estate assets this week because of the ongoing threat of losing deals,” the manager wrote in an Aug. 17, 2004 e-mail posted on the Senate website.

To contact the reporter on this story: Zeke Faux in New York at zfaux@bloomberg.net.

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net.

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