US Sues S&P Over Mortgage-Bond Ratings

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February 05, 2013
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Five years after the housing market almost brought down the global economy, the U.S. government sues S&P over its ratings system.

The U.S. Department of Justice today filed a civil suit against Standard & Poor’s Rating Services, arguing the firm failed to follow certain guidelines in the ratings of mortgage-backed securities (MBS), alleging that the oversights contributed to the causes of the financial collapse of 2008.

The argument, according to the Wall Street Journal, is that S&P’s Ratings Services ignored its own standards to rate mortgage bonds in 2007, leading many subprime market-linked MBS and other related collateralized debt obligations (CDOs) to receive higher ratings than they deserved.

Eventually, it was the collapse of the subprime mortgage market that triggered the country’s financial crisis. It helped push the economy into what many analysts consider to have been the worst downturn since the Great Depression. A housing recovery is still seen as crucial to a lasting U.S. economic turnaround.

S&P is one of the three largest ratings agencies in the country, and it’s unclear why the government would be zeroing in it. Indeed, all of them, including Fitch and Moody’s, have been at one time or another the focus of ratings criticism in the aftermath of the housing market collapse.

S&P defended itself in a press release, saying its ratings were based on the same information available to all market participants and were much the same as the ratings promulgated by its competitors.

“The DOJ and some states have filed meritless civil lawsuits against S&P challenging some of our 2007 CDO ratings and the underlying RMBS models,” S&P said in its statement. “Claims that we deliberately kept ratings high when we knew they should be lower are simply not true.”

How It Happened

The plethora of CDOs that S&P and other agencies rated so highly arguably extended the housing boom, by allowing banks to sell loans, thereby freeing them to continue loaning—increasingly to unqualified borrowers.

And indeed, CDOs, it turned out, had many bad credits buried within them, which brought storied investment banks such as Bear Stearns and Lehman Brothers that had bought so many of them to their knees.

The collapse of those institutions that are the very center of well-functioning credit markets sparked a full-blown global economic crisis as it quickly became clear that CDO buyers were located all over the planet, and the loans within particular CDOs were also linked to geographically diverse properties. Some observers have said that the web of complexity related to CDOs is so intricate that it will never be fully unraveled and understood.

“Although we deeply regret that these 2007 CDO ratings did not perform as expected, 20/20 hindsight is no basis to take legal action against the good-faith opinions of professionals,” S&P said.

The government is said to be looking for penalties of as much as $1 billion, but settlement talks appear to have broken down after four months, the WSJ reported.

 

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