Moody’s Reaches $864 Million Subprime Ratings Settlement

  • Agreement is victory for U.S. in probes of ratings industry
  • Pact helps resolve a long-standing overhang for Moody’s

Moody’s Corp. agreed to pay almost $864 million to resolve a multiyear U.S. investigation into credit ratings on subprime mortgage securities, helping to clear the way for the firm to move beyond its crisis-era litigation.

Moody’s reached the agreement with the U.S. Justice Department and 21 states, which accused the company of inflating ratings on mortgage securities that were at the center of the 2008 financial crisis, the Justice Department said Friday in a statement. That penalty is about a third of the $2.5 billion that Moody’s earned in the four years leading up to the crisis. Standard and Poor’s, after fighting the U.S. in court for two years, settled similar claims with the U.S. for $1.5 billion last year.

While Moody’s failed to abide by its own standards in rating some securities according to the government, it said the settlement doesn’t contain a finding it violated the law or any admission of liability.

“The agreement acknowledges the considerable measures Moody’s has put in place to strengthen and promote the integrity, independence and quality of its credit ratings,” the company said in an e-mailed statement. “Moody’s has agreed to maintain, for the next five years, a number of existing compliance measures and to implement and maintain certain additional measures over the same period.”

Since the financial crisis, the bulk of government settlements have been shouldered by the biggest banks, which have paid more than $162 billion in fines and penalties. The Obama administration has been criticized for years for failing to hold individuals accountable for misconduct leading to the crisis.

Still, the settlement over ratings by Moody’s Investors Service helps the administration move closer to wrapping up investigations of Wall Street firms for their actions leading up to the 2008 mortgage meltdown, a catastrophe that the Financial Crisis Inquiry Commission said wiped out $11 trillion of American household wealth. The credit ratings industry has been the target of these investigations into Wall Street for years.

Banks Balked

The Justice Department sued Barclays Plc in December for fraud over its sale of mortgage bonds after the bank balked at paying the amount the government sought in negotiations. The lawsuit is rare for big banks, which typically settle with the government rather than risk drawn-out litigation and a possible trial. The next day, Deutsche Bank AG and Credit Suisse Group AG said they had agreed to pay a combined $12.5 billion to resolve similar cases, though final settlements with the government haven’t yet been announced.

Friday’s settlement calls for Moody’s to pay $437.5 million to the Justice Department and $426.3 million to the states. California, an epicenter of the subprime debacle, will get $150 million from the agreement, the state’s attorney general said in a statement.

An after-tax charge of about $702 million, $3.62 per share, will be recorded in the fourth quarter of 2016, Moody’s said in its statement.

Both Moody’s Investors Service, a unit of Moody’s Corp., and S&P played key roles in Wall Street’s making of toxic, subprime mortgage bonds. While subprime home loans typically go to borrowers with the weakest credit, bonds backed by those mortgages received top-flight, AAA credit ratings. The bonds began coming apart in 2007 as the housing market collapsed, contributing to more than $1.9 trillion in losses at financial firms worldwide during a crisis that almost collapsed the global banking system.

AAA Junk

Investigators in Congress found after the crash that in some cases, credit rating firms were giving out top grades to junk deals simply to win business from the banks preparing the securities. 

In 2007, Moody’s said in public filings that it had ratings relationships with more than 11,000 corporate issuers, 26,000 public finance issuers, and that it had rated more than 110,000 structured finance securities, comprised primarily of mortgage bonds. As housing prices began to tumble that year, Moody’s downgraded 83 percent of the $869 billion in mortgage bonds it had rated AAA in 2006.

"This crisis could not have happened without the rating agencies," the Financial Crisis Inquiry Commission concluded in 2011.

Today, Moody’s remains the second-largest ratings company after S&P, and together with Fitch Ratings, these three bond graders still have over 96 percent market share -- a bigger hold than the government reported last year. In 2007, the triopoly graded 98.8 percent of bonds outstanding, according to government data.

‘Structured by Cows’

In troves of e-mails made public by Congress, S&P executives were caught criticizing their own ratings. “We rate every deal. It could be structured by cows, and we would rate it,” read one e-mail exchange between S&P executives. The Justice Department later included that exchange in its own lawsuit against S&P.

Whereas many outside observers viewed S&P’s e-mails as severely damaging and an indictment in the public perception, few such e-mails from within Moody’s have emerged. That stoked a broadly held view in the industry that the Justice Department could have a harder time proving misconduct of Moody’s.

“We’ve known for years that conflicts of interest at credit-rating firms were a significant factor in causing the 2008 financial crisis,” Senator Al Franken, a Minnesota Democrat, said when Moody’s announced that it expected to be sued. “We can’t let Wall Street be above the law," he said.

Franken has proposed doing away with the rating industry’s payment model, and in the writing of the 2010 Dodd-Frank Act targeted the way that bond issuers pay for their own debt to be assessed. The Securities and Exchange Commission, in its consideration of reform proposals, ultimately decided to keep the same business model for the industry in place. Since then, complaints have persisted that ratings shopping is alive and well in mortgage- and asset-backed bond markets.

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