S&P's $1.5 Billion Deal on Inflated Ratings Brings the Crisis Cleanup Near an End

Standard & Poor's pays a fat penalty, confesses no wrongdoing, and leaves big questions hanging about how credit is rated


Standard & Poor's today settled government accusations that it inflated ratings of mortgage-backed investments, helping feed a Wall Street frenzy that brought the world economy to its knees. No surprise, really. These massive cases are almost always settled. But what does it mean?

Government efforts to punish bubble-era excesses are drawing to a close

S&P's $1.5 billion in pacts with federal and state agencies follows more than $40 billion in similar deals struck by sundry financial institutions accused of contributing to the 2008 financial crisis. Add it up and you have the collective cost of doing risky business on Wall Street. Some storied outfits—Lehman Brothers, Bear Stearns—collapsed, but most, including S&P, continue more or less as they did before. Once again, in the S&P case, no top-level executives have read their names on criminal indictments, despite earlier government allegations of deceit and chicanery. This, for better or worse, is the best that prosecutors believe they can do.

What, exactly, did S&P do? 

Attorney General Eric Holder summed it up this morning: “The company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised,” he said. The implosion of those financial products (read: investments) triggered a larger credit panic that destroyed individual portfolios and imperiled mighty investment banks. “While this strategy may have helped S&P avoid disappointing its clients," Holder added, "it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.” In the end, though, S&P didn't admit to reckless conduct, let alone fraud. Instead, it was allowed to issue the usual boilerplate about settling "to avoid the delay, uncertainty, inconvenience, and expense of further litigation." To put the settlement amount in perspective: It will wipe out the annual profit of S&P's parent company, McGraw Hill Financial, which last year came in at about $1 billion. Over the long term, though, Bloomberg News noted, S&P's decision to end its costly legal battle with Washington and more than a dozen states "will help the company close a profit gap with its largest competitor, Moody's Corp." So that's promising news for McGraw Hill shareholders. 

How had S&P defended its objectionable conduct?

Before this case fades into the mists of Wall Street memory, let's recall S&P's fabulously offensive justifications. Historically, the company rebuffed lawsuits attacking allegedly careless bond ratings by invoking the First Amendment's free speech protection. Our opinions may be worthless, S&P said, but they're just opinions. The Justice Department tried to pierce the First Amendment defense by accusing S&P of a rank conflict of interest: shaping its ratings of mortgage-backed deals to please the banks that designed the investments and paid for the ratings. S&P, prosecutors contended, falsely claimed that its assessments were "objective, independent, [and] uninfluenced by any conflicts of interest." In earlier stages of the government fraud case, S&P responded with a second legal defense, one that only lawyers can discuss with a straight face. The company said that its claims to objectivity and independence were "mere puffery," the sort of marketing blarney that sophisticated investors don't believe. If that sounds as if S&P played the integrity card both ways--take our ratings seriously ... until we decide they're not serious at all—well, that's exactly what happened.

What about the retaliation conspiracy theory?

In a further defensive maneuver, S&P alleged that the Justice Department had singled it out for unwelcome attention in retaliation for the rating agency's 2011 downgrade of U.S. debt. The Obama administration denied this accusation, saying its investigation of S&P predated the downgrade, although it is curious that only S&P faced federal hostility when its rivals—especially Moody's—issued similarly off-the-mark ratings of bubble-era investments. As part of the settlement, the Justice Department required S&P to back off the retaliation claim. While we'll probably never get to the bottom of whether S&P's downgrade precipitated its legal troubles, one thing that is clear in retrospect is that the firm's failure to anticipate the economic recovery taking shape just as it made a bearish call in 2011 ought to raise yet another layer of skepticism about the value of any S&P ratings.

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