Credit Ratings and Broken Knees: Did Geithner Threaten S&P's Chairman?

Former Treasury Secretary Timothy Geithner in 2012 Photograph by Chris Usher/CBS News via AP Photo

The Justice Department’s $5 billion fraud case against Standard & Poor’s is starting to sound like a Godfather movie. Or that, anyway, is what the chairman of the rating agency’s corporate parent, McGraw Hill Financial, would have you believe.

The allegation by Harold McGraw III that former Treasury Secretary Timothy Geithner threatened S&P with unspecified retribution as punishment for a downgrade of U.S. debt has the ring of a litigation tactic—but a clever one, and one that ought to force the government to clarify why it singled out S&P, as opposed to its rating-industry rivals.

The background: Last year Justice accused S&P of covering up alleged conflicts of interest infecting its ratings of mortgage-backed securities in the runup to the 2008 financial crisis. The government is seeking as much as $5 billion in civil penalties. S&P has tried to fend off the suit with several arguments. First, S&P says that no reasonable investor took seriously its claims of integrity and objectivity. The humiliating “mere puffery” defense (lawyers really call it that) so far hasn’t gained much traction. A second, equally humiliating argument S&P makes is that its ratings may have been incompetent but they weren’t fraudulent. The we’re-dumb-but-not-dishonest defense (I call it that) could actually work if this case ever gets to a jury.

A third pitch—the Godfather scenario—is that the Justice Department suit is a venal form of revenge for the rating agency’s decision in 2011 to downgrade U.S. debt. Our colleagues at Bloomberg News ably summarize the latest development:

“S&P filed a declaration by McGraw yesterday [Jan. 20] in federal court in Santa Ana, California, as part of a request to force the U.S. to hand over potential evidence that the company says will support its claim that the government filed a fraud lawsuit against it last year in retaliation for its downgrade of the U.S. debt two years earlier. In his court statement, McGraw, 65, said Geithner called him on Aug. 8, 2011, after S&P was the only credit ratings company to downgrade the U.S. debt. Geithner, McGraw said, told him that S&P would be held accountable for the downgrade. Government officials have said the downgrade was based on an error by S&P. ‘S&P’s conduct would be looked at very carefully,’ Geithner told McGraw, according to the filing. ‘Such behavior would not occur, he said, without a response from the government.’”

The Obama administration and Geithner were quick with their denials. There’s “no connection” between the 2011 downgrade and the subsequent government lawsuit, Ellen Canale, a spokeswoman for the Justice Department’s Financial Fraud Enforcement Task Force, told Bloomberg. “The allegation that former Secretary Geithner threatened or took any action to prompt retaliatory government action against S&P is false,” Jenni LeCompte, a spokeswoman for Geithner, said in an e-mailed statement.

Here are my questions:

1. If Terry McGraw, the scion of a legendary corporate family and head of a powerful financial analysis empire, thought he was threatened by Geithner in 2011, why didn’t he speak up sooner? The allegation of gangster-like arm-twisting, if taken seriously, suggests moral corruption at the highest levels of government. Wasn’t it McGraw’s duty to reveal this supposed misconduct when it happened?

2. On the other hand, why did the Obama administration go after S&P alone for the rating fiasco? Moody’s and Fitch issued ratings identical to S&P’s, yet the Justice Department didn’t name them as defendants. Why not?

3. Shouldn’t the Justice Department view McGraw’s gambit as an occasion to embarrass the McGraw-Hill chairman as a cry-baby and/or liar, if indeed the reasons for singling out S&P were legitimate? Why not disclose some of litigation planning documents that S&P wants to see. If the documents describe a kosher process of isolating S&P—perhaps because the evidence against that agency is more graphic and easier for potential jurors to understand—then there’s a perfectly understandable argument for the government to make: When enforcing the financial laws, it’s not feasible to sue every single miscreant. The feds go after provable misbehavior on the theory that such action has a broader deterrent effect in the marketplace. S&P is in the cross hairs not because it downgraded U.S. debt but because it’s the largest rating company and the one whose internal e-mails, memos, and other evidence allow outsiders to see what went wrong with a process that rubber-stamped “AAA” on all those complex securities that blew up, bringing Wall Street and the wider economy to their knees.

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