Eric Holder alleges S&P mortgage ratings favored issuers over investors
U.S. Attorney General Eric Holder broke his silence Tuesday on the Justice Department and numerous states' filing of a civil suit against Standard & Poor's Financial Services, and its parent company McGraw-Hill, for allegedly misleading investors who put money behind residential mortgage-backed securities and collateralized debt obligations.
Holder told the markets and investors that the DOJ and numerous states allege in a civil complaint that S&P "falsely claimed that its ratings were independent, objective, and not influenced by the company's relationship with issuers who hired S&P to rate the securities in question."
Holder's team, on the other hand, claims the ratings were anything but independent.
S&P defended the firm's actions Tuesday, providing its website visitors with links to an explanation of how the firm's ratings are handled and to information on how rating policies have been strengthened to ensure independence.
"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. "Claims that we deliberately kept ratings high when we knew they should be lower are simply not true."
S&P went on to say it regrets that 2007 CDO ratings did not perform as expected, but added "20/20 hindsight is no basis to take legal action against the good-faith opinions of professionals."
The firm added, "The fact is that S&P's ratings were based on the same subprime mortgage data available to the rest of the market – including U.S. Ggovernment officials who in 2007 publicly stated that problems in the subprime market appeared to be contained. Every CDO cited by the DOJ also independently received the same rating from another rating agency."
The investment deals in question were rated at a time when toxic and risky loans were allegedly being bundled, rated and sold off to investors as a matter of routine.
For many, including Holder, the ratings giants were supposed to be the final line of defense to protect investors from unseen risks tied to whatever they were buying, says John Taylor, chief executive officer of the National Community Reinvestment Coalition (NCRC).
Eric Holder noted that after an investigation into S&P documents, the DOJ concluded that, in reality, the ratings were soiled by conflicts of interest and S&P was primarily "driven by a desire to increase its profits and market share to favor the interests of issuers over investors," Holder said in a statement.
Holder's announcement wasn't news to John Taylor with NCRC. Long a critic of how S&P, Fitch and Moody's Investors Co. handled securities ratings tied to mortgages, Taylor has been waiting for this moment for more than four years.
Before the market collapse in 2008, Taylor remembers walking into S&P to meet with what he thought would be a program officer to go over how some of the investment vehicles tied to riskier loans obtained triple-A ratings. Instead of meeting with a program officer, Taylor was pulled into a room with an executive level employee and a general counsel, he says.
"I remember thinking immediately I must be onto something … these were the top-brass," Taylor said. "You don't send the top brass when I just wanted to understand how they had triple-A rated these loans." He remembers being shocked by reaching the personal conclusion that S&P did not function – nor proclaim to function – as a due diligence firm.
"I just walked away from there thinking 'we are in trouble,' and this is before the crash," Taylor told HousingWire.
As for the DOJ suit, he suspects other credit rating agencies could eventually face a similar complaint, although nothing of the sort has been confirmed by the DOJ.
"I think all three rating agencies are probably being investigated – the other two as well," he said. "I don't see any reason why there would not be a similar complaint filed against Moody's and Fitch, they practiced the same thing," Taylor noted.
Yet, he's surprised it took so long for any case to be filed. The NCRC filed its own complaint with the Securities and Exchange Commission against Fitch, Moody's Investors Service and S&P back in 2008. At the time, NCRC claimed the agencies "substantially contributed to the housing and foreclosure crisis by making public misrepresentations about the soundness and reliability of securities filings."
The following year, NCRC filed a civil rights complaint with HUD, alleging S&P's credit ratings "substantially contributed to the housing and foreclosure crisis" in minority neighborhoods due to alleged misrepresentations made about the soundness and reliability of subprime securities ratings.
Since then, Taylor has heard nothing from the agencies about the complaints. "Hopefully this will spur them to dust off the files and do something about the complaints that I filed," he told HousingWire.
The DOJ's case was brought under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, which lets the DOJ seek civil penalties on losses suffered by federally insured financial institutions, Holder's office said.
The DOJ claims that, to date, it has identified "more than $5 billion in such losses, resulting from CDOs that were rated by S&P between March and October 2007." Holder's office says during that period "nearly every single-mortgage-backed CDO that was rated by S&P not only underperformed – but failed."
The DOJ's civil complaint prompted numerous announcements, including one from Illinois Attorney General Lisa Madigan, who previously filed her own lawsuit in Cook County Circuit Court against S&P.
In a statement, Madigan says her lawsuit cites testimony from a former managing director for S&P who said during Congressional testimony that "profits were running the show" with ratings driving profit margins for clients.
Manal Mehta with Sunesis Capital said, "The details surrounding S&P's extraordinary efforts to allow banks to fraudulently move warehouse risk from their balance sheet by packaging it into CDOs to sell to unsuspecting investors highlights the clear role that they played as enablers of the grand fraud that led to the financial crisis."
S&P further responded to the DOJ suit, saying e-mails cited in the complaint were "cherry-picked" and that the firm "will vigorously defend S&P against these unwarranted claims."
The ratings giant added, "S&P has always been committed to serving the interests of investors and all market participants by providing independent opinions on creditworthiness based on available information. At all times, our ratings reflected our current best judgments about RMBS and the CDOs in question."