Is S&P Being Sued Because It Downgraded the U.S.?

Why is the Justice Department suing Standard & Poor's for mis-rating structured credit securities before the financial crisis, and not suing Moody's, which gave a lot of the same products the same ratings?
I looked for a really intimidating picture of Tim Geithner but fell back on the old standby. An S&P analyst once said "it could be structured by cows and we would rate it" and as long as I'm captioning photos they'll never live it down. Photographer: Luke Sharrett/Bloomberg

Why is the Justice Department suing Standard & Poor's for mis-rating structured credit securities before the financial crisis, and not suing Moody's, which gave a lot of the same products the same ratings? I have a theory, 1 but Standard & Poor's has another theory, and theirs is a corker:

The most obvious explanation is apparent. S&P alone among the major rating agencies downgraded the securities issued by the United States. As described below, the chronology of events relating to the downgrade and the commencement of this lawsuit provides powerful evidence linking the two. And beyond this showing, S&P submits with this motion the affidavit of the Chairman and, in August 2011, Chief Executive Officer and President of McGraw Hill, Harold McGraw III. Mr. McGraw describes personal communications made to him first on behalf of the Secretary of the Treasury, and then personally by the Secretary himself in the days following the downgrade. The Treasury Secretary angrily chastised S&P for the downgrade, stating that S&P's conduct would be "looked at very carefully" and that such behavior could not occur without a response from the United States.

Well! I mean, lots of people have had that theory. I would link to some of them, but S&P's motion that I just quoted comes with a helpful chronology of all the publications that have hinted at that theory, so you can just read that. 2 That chronology comes stapled to Harold McGraw's affidavit (McGraw Hill owns S&P) recounting the dramatic story of how Tim Geithner threatened him. It's sort of a nuanced story:

Mr. Geithner expressed anger at the downgrade. In the course of our discussion, he referred to an asserted two trillion dollar error in S&P's work, an error that he had described in various discussions with the media following the announcement of the downgrade. Having been briefed on the issue by S&P personnel in the wake of those statements by Mr. Geithner, I explained to him that in relying on Congressional Budget Office figures, as it had, S&P had not made an error. Mr. Geithner said that S&P had made a huge error and that "you are accountable for that." He added that S&P had a previous history of errors and that this was not the first mistake it had made.

As I reported contemporaneously to my colleagues, he said that "you have done an enormous disservice to yourselves and to your country", that the U.S. economy was bad and that the downgrade had done real damage. S&P's conduct would be "looked at very carefully" he said. Such behavior could not occur, he said, without a response from the government.

So, S&P did have a previous history of errors, and the $2 trillion thing was not the first mistake it had made! That's plausibly part of a reasoned discussion of the issues, rather than a "nice nationally recognized statistical rating organization you've got there, shame if a regulator were to bring a civil case against it" sort of thing. Also, Tim Geithner probably isn't the guy who decides what lawsuits the Justice Department brings. But, sure, McGraw probably felt intimidated.

The fun thing is what S&P is doing now, which is fighting the Justice Department's lawsuit on the theory that it was only brought to retaliate against S&P for exercising its First Amendment rights. (You have a First Amendment right to downgrade the U.S., look it up.) Yesterday's motion was filed to demand discovery on that theory, seeking (among other things) documents from the government that refer both to S&P's downgrade of the U.S. and to the investigation into S&P's pre-crisis ratings. What will they find? Oh who knows. I don't think you can entirely rule out the possibility that the Justice Department wants to punish S&P for more than just mis-rating securities, or the related possibility that someone at DoJ said something like that in an e-mail. Though you'd hope that long experience of reading bankers' dumb e-mails would make them more careful.

But here's the thing: All of that is pretty much irrelevant to the question of whether S&P mis-rated securities. It just gets to the question of whether S&P was unfairly singled out for mis-rating securities that everyone else was mis-rating too. And, ordinarily, "everybody else was doing it" is not much of a defense to charges of fraud and misbehavior. That's true whether the government actually goes after everyone, 3 or just does a few exemplary prosecutions and calls it a day. 4 If you and your biggest competitor both do the same exact fraudy thing, and the government charges you and leaves your competitor alone: Tough! That's up to the government.

S&P seems to have found a loophole: If the government is singling you out to retaliate against you for exercising your First Amendment rights to criticize the government, then perhaps you can get the case dismissed. 5 Or, at least, you can demand enough embarrassing internal government communications to make the government think twice about bringing charges.

If this works, it's quite a discovery! You occasionally hear speculation that JPMorgan's horrible year of fines last year was driven in part by retaliation for Jamie Dimon's outspokenness on regulation, and on everything, but imagine JPMorgan fighting some of those fines by making that claim, and seeking documents from regulators to back it up.

Even better, it shifts the incentives a bit. Financial firms generally want to be on good terms with their regulators, and to avoid criticizing them publicly. But S&P's defense suggests that the opposite strategy might have some appeal: Just criticize your regulators constantly and harshly and in as high-profile a way as possible. Then, if they ever do go after you, argue that it's just retaliation for the criticism. Criticizing your regulators could serve as (pretty weak, but still) insurance against lawsuits from those regulators. Plus, it's more fun than pretending to approve of everything they do.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
  1. There are claims that (1) Moody's was rating those securities pretty generously to begin with, (2) S&P was worried about losing business to Moody's, so (3) S&P relaxed its standards to be closer to Moody's. If you believe this narrative -- and there are gaps and exceptions and so forth in it -- then Moody's looks worse than S&P, which at least tried to be strict for a while but eventually gave up. But S&P looks easier to sue, because there are lots of emails to the effect of "hey let's relax our standards to be more competitive with Moody's." I have a similar theory about JPMorgan in China.

    As general background I think that the lawsuit against S&P is pretty silly on its terms, though the impulse to get mad at S&P for misrating everything that caused the financial crisis is pretty understandable. Anyway here's what I said about the lawsuit when it came out.

  2. Highlights include the Atlantic saying "Even if this investigation was started before any of this downgraded business began, it is now hopelessly compromised"; McClatchy Newspapers quoting a "person familiar with the case" saying "After the U.S. downgrade, Moody's is no longer part of this"; a Wall Street Journal editorial, and the Guardian pointing out that:

    Egan Jones and S&P share two characteristics that should raise an eyebrow: both downgraded the US and subsequently faced disciplinary action from the US government. Perhaps this helps explain why Moody's chose to downgrade the UK while leaving the US at Aaa.
  3. As they have in, for instance, CDO fraud cases, where pretty much every bank paid a big settlement for doing stuff that they all seem to have thought was market standard. Libor is shaping up to be broadly similar.

  4. That's one way to view the SAC-related insider trading cases. Lots of people were involved and not charged, for one thing. For another thing, if talking to investor relations people at companies is illegal, a lot of investors should be in jail.

  5. That's their theory. I ... don't know? The cases they cite don't exactly say that, as far as I can tell. But, whatever, seems reasonable.

To contact the author on this story:
Matthew S Levine at

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