S&P as Sole U.S. Target Has Wall Street Asking About Moody’s
The Justice Department decision to sue Standard & Poor’s has investors asking why Moody’s Investors Service and Fitch Ratings weren’t targeted for awarding the same top grades to troubled mortgage bonds and other debt securities.
“What purpose does it serve for the U.S. government to bring an action against S&P at this point in time? On the surface, is this a bid for some sort of retribution” for the company’s 2011 downgrade of the U.S., Bonnie Baha, head of global developed credit at Los Angeles based DoubleLine Capital LP, which oversees about $53 billion, said in a telephone interview yesterday. “Moody’s and Fitch assigned the same ratings to these transactions. Why aren’t they named as well?”
The Financial Crisis Inquiry Commission and a Senate panel laid the blame on S&P, Moody’s and Fitch for inflated ratings on mortgage-backed securities and collateralized debt obligations that helped cause the worst financial crisis since the Great Depression. Together, they provided 96 percent of all ratings for governments and companies in the $42 trillion debt market in 2011.
The U.S., in a lawsuit filed Feb. 4 in federal court in Los Angeles, is alleging that the unit of New York-based McGraw-Hill Cos. defrauded investors by failing to adjust its analytical models or taking necessary steps to accurately reflect the risks of the securities because it was afraid of losing business.
S&P lowered the U.S. government’s credit rating one step to AA+ from the top AAA rank on Aug. 5, 2011, after months of wrangling between President Barack Obama and Congressional Republicans over whether to raise the federal debt limit. Bond investors repudiated the downgrade and U.S. borrowing costs fell to record lows as Treasuries gained the most since 2008.
Debt markets have judged ratings company rankings to be unimportant, Baha said. “My question is, why are U.S. taxpayers wasting money to prove a fact that’s already widely accepted in the market?” she said.
The Justice Department’s case “looks rather suspicious” because Moody’s isn’t involved, said Peter Wallison, co-director of the Washington-based American Enterprise Institute’s program on financial policy and a member of the inquiry commission.
“It’s very hard to see how Moody’s was doing anything differently than S&P,” he said yesterday in a telephone interview.
S&P has used this as a defense. Floyd Abrams, the Cahill Gordon & Reindel LLP lawyer representing the company, said in a Feb. 5 appearance on Bloomberg Television that investors required two ratings on CDOs before they would buy.
“And yet we find ourselves now being accused of acting in bad faith, while everyone else acted in good faith, presumably,” he said on the “Lunch Money” program with Sara Eisen. He said on CNBC the same day that the Justice Department’s investigation intensified after the S&P downgrade, though he didn’t know if there was a direct link. “No one in the government has come to me and said, ‘That’s why we did it,’” Abrams said.
Ed Sweeney, an S&P spokesman, declined to elaborate on Abrams’s comments.
Attorney General Eric Holder said Feb. 5 in Washington that the complaint against S&P was unrelated to the downgrade.
“There’s no connection between the two,” he said. “They did what they did, assessing what the creditworthiness was of this nation. We looked at the facts, the law and the investigation” and “made a determination that the filing of these lawsuits was appropriate.”
McGraw-Hill has dropped 24.9 percent in New York trading this week, set for the biggest weekly decline in data going back to August 1980. The stock lost 23.8 percent in the week ended Oct. 10, 2008, during the height of the global financial crisis. Moody’s has decreased 15.1 percent in the same period, poised for the biggest retreat since the week ended Sept. 25, 2009.
Yields on McGraw-Hill’s $400 million of bonds due November 2037 have increased 34 basis points this week to 5.78 percent, the highest level since March, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Yields on Moody’s $500 million of securities due September 2022 advanced 8 basis points to 4.095 in the period.
S&P rated more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion of CDOs from September 2004 through October 2007, according to the complaint. Many were rated AAA. S&P downplayed the risks on portions of the securities to gain more business from the investment banks that issued them, the U.S. said.
The collapse in value of securities that packaged home loans from the riskiest borrowers led to a credit seizure starting in 2007 that sent the world’s largest economy into its deepest recession since 1933, from which it has yet to recover 3.23 million of the 8.74 million jobs lost. It also left financial institutions, including those with federal insurance, nursing billions of dollars of losses.
Wallison said the largest shareholder in Moody’s is Warren Buffett’s Berkshire Hathaway Inc. (BRK/A) Buffett is an Obama supporter and his name is associated with a proposal to raises taxes on the wealthiest Americans promoted by the administration.
“There are peculiar things about this particular lawsuit,” Wallison said. He said there’s no way to know for sure why S&P is alone in facing the U.S. lawsuit.
Buffett didn’t respond to a request for comment left with an assistant.
There is still the chance that Moody’s will be named by the government, Peter Tchir, founder of New York-based TF Market Advisors, said yesterday in a telephone interview. “It has to come at some point. It would be hard to say one guy was rating a AAA completely fraudulently but the other guy was fine.”
The Justice Department may sue Moody’s after the S&P case is tested in the courts, Reuters reported late yesterday, citing people familiar with the matter it didn’t name.
In September, Moody’s said it may join S&P in downgrading the U.S.’s credit rating unless Congress this year reduces the percentage of debt-to-gross-domestic-product during budget negotiations.
‘Far From Clear’
Michael Adler, a spokesman for Moody’s in New York, declined to comment.
Fitch Ratings said Feb. 5 it has “no reason to believe” it faces a lawsuit from the U.S. Dan Noonan, a spokesman in New York for Fitch, said the company stands by that statement.
U.S. success in the lawsuit in federal court in Los Angeles is “far from clear,” said Jeffrey Manns, an associate professor at George Washington University Law School. S&P’s defense may include evidence that the agency believed in its ratings and proof that U.S. fraud allegations are unfounded. Company lawyers are also weighing whether to argue that the 1989 statute underpinning the case doesn’t apply to S&P.
“We start with proposition that we deny there was any fraud,” Abrams said yesterday in telephone interview. Fraud claims have “a high burden of proof.”
Moody’s, S&P and Fitch are being investigated by the New York Attorney General over whether the companies breached a 2008 settlement with the state, a person familiar with the matter said yesterday.
The companies reached an agreement with then-Attorney General Andrew Cuomo that required them to adopt changes to their operations. Eric Schneiderman, the current attorney general, is probing whether they complied with the agreement, said the person, who wasn’t authorized to speak publicly about the probe and asked not to be identified.
Moody’s Adler and Fitch’s Noonan didn’t immediately respond to e-mails yesterday after regular business hours seeking comment about the New York probe.
Catherine Mathis, an S&P spokeswoman, declined to comment on the probe.
The Justice Department’s investigation started long before the downgrade, said Janet Tavakoli, founder of Chicago-based consulting firm Tavakoli Structured Finance Inc.
“That’s just their spin,” she said, referring to S&P. “There’s been ample evidence that they’ve been incompetent in their jobs.”
Enough evidence exists for the Securities and Exchange Commission to strip S&P of its designation as a Nationally Recognized Statistical Rating Organization, or NRSRO, which allows the firm to sell rankings, she said.
“All these ratings firms have not been held accountable by the SEC,” said Tavakoli, who wrote a 2011 research note titled “Tavakoli Structured Finance Revokes the Credit Rating Agencies’ NRSRO Designation.”
John Nester, an SEC spokesman in Washington, declined to comment on “vague criticisms,” saying in an e-mailed statement that the agency has “taken numerous significant actions to increase transparency, reduce conflicts and promote ratings with integrity, and we will continue to do so.”
Tavakoli also faulted the legal merits of the case, which relies in part on internal e-mails.
“We rate every deal,” one S&P analyst said in an e-mail cited in the complaint. “It could be structured by cows, and we would rate it.”
The complaint includes at least 58 examples of S&P executives ignoring internal warnings from analysts and others, dismissing relevant data, taking steps to appease issuers or acknowledging how pressure from banks could lessen the quality of its grades or delay downgrades.
“If all it takes for people to incriminate themselves is e-mails, it would be very easy to be a lawyer,” Tavakoli said.
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