Henny Ray Abrams, File, Associated Press
WASHINGTON — The U.S. government accused Standard & Poor's of inflating ratings on mortgage investments to boost its bottom line, taking aim at a key player in the run-up to the financial crisis.
In charges filed late Monday in Los Angeles federal court, the Justice Department said S&P gave high marks to mortgage-backed securities that later went sour, even though it knew they were risky. The government said S&P misrepresented the risks because it wanted more business from the banks.
The case is the government's first major action against one of the credit rating agencies that stamped their seals of approval on Wall Street's mortgage bundles. It marks a milestone for the Justice Department, which has been criticized for failing to make bigger cases against the companies involved in the crisis.
"Put simply, this alleged conduct is egregious — and it goes to the very heart of the recent financial crisis," Attorney General Eric Holder told a news conference Tuesday. He called the case "an important step forward in our ongoing efforts to investigate and punish the conduct that is believed to have contributed to the worst economic crisis in recent history."
Rating agencies are widely blamed for contributing to the financial crisis that crested in 2008 and caused the deepest recession since the Great Depression. They gave high ratings, indicating little risk for investors, to pools of mortgages and other debt assembled by big banks and hedge funds. That gave even risk-averse investors the confidence to buy them.
Some investors, including pension funds, can only buy investments that carry high ratings. In effect, rating agencies like S&P greased the assembly line that allowed banks to push risky mortgages out the door.
When the housing market turned in 2007, the agencies acknowledged that mortgages issued during the bubble were far less safe than the ratings indicated. They lowered the ratings on nearly $2 trillion worth, spreading panic that spiraled into a crisis.
S&P, a unit of New York-based McGraw-Hill Cos., has denied wrongdoing. It says the government also failed to predict the subprime mortgage crisis.
The government's lawsuit says S&P was more concerned with making money than issuing accurate ratings. It says the company delayed updating its ratings models, rushed through the ratings process and kept giving high ratings even after it was aware that the subprime market was flailing even as it gave high marks to investments made of subprime mortgages. In 2007, one analyst forwarded a video of himself singing and dancing to a tune about the deterioration of the subprime market, with colleagues laughing.
The government, for its part, has been widely criticized for not pursuing financial crisis wrongdoing as doggedly as some might have hoped. Lance Roberts, chief economist at Streettalk Advisors in Houston, Texas, called the lawsuit "about three years too late."
"The government's just now getting around to filing a lawsuit?" Roberts said. "It seems disingenuous to me. Why is there actually no regulation that occurs at the front end?"
Ratings agencies like S&P are a key part of the financial crisis narrative. When banks and other financial firms wanted to package mortgages into securities and sell them to investors, they would come to a ratings agency to get a rating for the security. Many securities made of risky subprime mortgages got high ratings, giving even the more conservative investors, like pension funds, the confidence to buy them. Those investors suffered huge losses when housing prices plunged and many borrowers defaulted on their mortgage payments.
This arrangement has a major conflict of interest, the government's lawsuit says. The firms that issued the securities could shop around for whichever ratings agency would give them the best rating. So the agencies could give high ratings just to get business.
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