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EDITOR’S NOTE: We told you so. Eventually the government would get so pissed off with the rating agencies, the empire would strike back and it won’t be pretty. The net result will be that people in the rating agencies will start rolling over — turning in evidence against the players who created the mess that resulted in the lower ratings for the U.S. government.

August 17, 2011

U.S. Inquiry Is Said to Focus on S.&P. Ratings


The Justice Department is investigating whether the nation’s largest credit ratings agency, Standard & Poor’s, improperly rated dozens of mortgage securities in the years leading up to the financial crisis, according to two people interviewed by the government and another briefed on such interviews.

The investigation began before Standard & Poor’s cut the United States’ AAA credit rating this month, but it is likely to add fuel to the political firestorm that has surrounded that action. Lawmakers and some administration officials have since questioned the agency’s secretive process, its credibility and the competence of its analysts, claiming to have found an error in its debt calculations.

In the mortgage inquiry, the Justice Department has been asking about instances in which the company’s analysts wanted to award lower ratings on mortgage bonds but may have been overruled by other S.& P. business managers, according to the people with knowledge of the interviews. If the government finds enough evidence to support such a case, which is likely to be a civil case, it could undercut S.& P.’s longstanding claim that its analysts act independently from business concerns.

It is unclear if the Justice Department investigation involves the other two ratings agencies, Moody’s and Fitch, or only S.& P.

During the boom years, S.& P. and other ratings agencies reaped record profits as they bestowed their highest ratings on bundles of troubled mortgage loans, which made the mortgages appear less risky and thus more valuable. They failed to anticipate the deterioration that would come in the housing market and devastate the financial system.

Since the crisis, the agencies’ business practices and models have been criticized from many corners, including in Congressional hearings and reports that have raised questions about whether independent analysis was corrupted by the drive for profits.

The Securities and Exchange Commission has also been investigating possible wrongdoing at S.& P., according to a person interviewed on that matter, and may be looking at the other two major agencies, Moody’s and Fitch Ratings.

Ed Sweeney, a spokesman for S.& P., said in an e-mail: “S.& P. has received several requests from different government agencies over the last few years. We continue to cooperate with these requests. We do not prevent such agencies from speaking with current or former employees.” S.& P. is a unit of the McGraw-Hill Companies, which is under pressure from some investors and has been considering whether to spin off businesses or make other strategic changes this summer.

The people with knowledge of the investigation said it had picked up steam early this summer, well before the debt rating issue reached a high pitch in Washington. Now members of Congress are investigating why S.& P. removed the nation’s AAA rating, which is highly important to financial markets.

Representatives of the Justice Department and the S.E.C. declined to comment, as is customary for those departments, on whether they are investigating the ratings agencies.

Even though the Justice Department has the power to bring criminal charges, witnesses who have been interviewed have been told by investigators that they are pursuing a civil case.

The government has brought relatively few cases against large financial concerns for their roles in the housing blowup, and it has closed investigations into Washington Mutual and Countrywide, among others, without taking action.

The cases that have been brought are mainly civil matters. In the spring, the Justice Department filed a civil suit against Deutsche Bank and one of its units, which the government said had misrepresented the quality of mortgage loans to obtain government insurance on them. Another common thread — in that case and several others — is that no bank executives were named.

Despite the public scrutiny and outcry over the ratings agencies’ failures in the financial crisis, many investors still rely heavily on ratings from the three main agencies for their purchases of sovereign and corporate debt, as well as other complex financial products.

Companies and some countries — but not the United States — pay the agencies to receive a rating, the financial market’s version of a seal of approval. For decades, the government issued rules that banks, mutual funds and others could rely on a AAA stamp for investing decisions — which bolstered the agencies’ power.

A successful case or settlement against a giant like S.& P. could accelerate the shift away from the traditional ratings system. The financial reform overhaul known as Dodd-Frank sought to decrease the emphasis on ratings in the way banks and mutual funds invest their assets. But bank regulators have been slow to spell out how that would work. A government case that showed problems beyond ineptitude might spur greater reforms, financial historians said.

“I think it would have a major impact if there was a successful fraud case that would suggest there would be momentum for legislation that would force them to change their business model,” said Richard Sylla, a professor at New York University’s Stern School of Business who has studied the history of ratings firms.

In particular, Professor Sylla said that the ratings agencies could be forced to stop making their money off the entities they rate and instead charge investors who use the ratings. The current business model, critics say, is riddled with conflicts of interest, since ratings agencies might make their grades more positive to please their customers.

Before the financial crisis, banks shopped around to make sure rating agencies would award favorable ratings before agreeing to work with them. These banks paid upward of $100,000 for ratings on mortgage bond deals, according to the Financial Crisis Inquiry Commission, and several hundreds of thousands of dollars for the more complex structures known as collateralized debt obligations.

Ratings experts also said that a successful case could hamper the agencies’ ability to argue that they were not liable for ratings that turned out to be wrong.

“Their story is that they should be protected by full First Amendment protections, and that would be harder to make in the public arena, in Congress and in the courts,” said Lawrence J. White, another professor at New York University’s Stern School of Business, who has testified alongside ratings executives before Congress. “If they mixed business and the ratings, it would certainly make their story harder to tell.”

The ratings agencies lost a bit of ground on their First Amendment protections in the recent financial reform bill, which put the ratings firms on the same legal liability level as accounting firms, Professor White said. But that has yet to be tested in court.

People with knowledge of the Justice Department investigation of S.& P. said investigators had made references to several individuals, though it was unclear if anyone would be named in any potential case. Investigators have been asking about a remark supposedly made by David Tesher about mortgage security ratings, two people said. The investigators have asked witnesses if they heard Mr. Tesher say: “Don’t kill the golden goose,” in reference to mortgage securities.

S.& P. declined to provide a comment for Mr. Tesher.

Several of the people who oversaw S.& P.’s mortgage-related ratings went on to different jobs at McGraw-Hill, including Joanne Rose, the former head of structured finance; Vickie Tillman, the former head of ratings; and Susan Barnes, former head of residential mortgage bond ratings. Investigators have told witnesses that they are looking for former employees and that has proved difficult because so many crucial people still work at the company.

One former executive who has been mentioned in investigators’ interviews is Richard Gugliada, who helped oversee ratings of collateralized debt obligations. Calls to his home were not returned.

7 Responses

  1. Will US plead Recklessness successfully on part of S&P?

    Will the courts reject S&P’s “Hey, the whole economy tanked” argument?

    Was the US passive victim?

    When we say US do we mean US TREASURY? vs. FEDERAL RESERVES’ Specific companies 12/15/2010: The underwriter defendants include Citigroup Global Markets Inc., UBS Securities LLC, Goldman Sachs & Col., J.P. Morgan Securities Inc., HSBC Securities (USA) Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, and Wachovia Capital Markets, LLC

    Did S&P statements and misrepresentations contribute to collapse of US credit rating causing substantive harms?

    Will US use ‘inference of frauds?

    How could US & S&P have foreseen?

    Was S&P an active participant in the collapse of the economy?
    Foir that matter, was the US ?

    Did S&P act with intent? by approving the specific companies financial paroducts, and related actions and public statements?

    Did S&P act with intent and negligent misrepresentations reward AAA over and over and over until point of collapse of economy and S&P beneficary of recklessness?

    On February 22, 2010, Southern District of New York Naomi Reice Buchwald granted in part and denied in part Ambac & defendants’ motion to dismiss in the consolidated securities case.

    Judge Buchwald cited numerous allegations which she found sufficient to show that Ambac’s officers were aware that “Ambac lowered its underwriting standards in several ways.”

    Among other things, she cited an internal October 2006 email to one of the defendants asking “Why are we willing to insure stuff in the secondary market [i.e., the CDO market] that we would not touch with a ten foot pole in the primary market [i.e., the RMBS market]?”

    Significant to consider what may be considered.
    Ambac one of the nations largest insurers of bonds.

    Did Ambac pay $27.1 million in cash, while the underwriter defendants agreed to pay an additional $5.9 million for their involvement in a 2007 securities offering, bringing the total settlement value to $33 million. The settlement is subject to approval by the Court.

    The Specific companies again 12/15/2010:
    Institutional investors underwriter defendants include

    Citigroup Global Markets Inc.,
    UBS Securities LLC,
    Goldman Sachs & Col.,
    J.P. Morgan Securities Inc.,
    HSBC Securities (USA) Inc.,
    Merrill Lynch, Pierce, Fenner & Smith Incorporated, and
    Wachovia Capital Markets, LLC

    No BOA covered by Merrilly Lyunch…
    Wells Fargo Bank NA – no covered by Wachovia Capital Markets renaming reorganizations.
    BONY? No covered by HSBC
    Deutsche Bank? No covered by Goldman
    Credit Suisse? Nope covered by UBS

    Following logic:

    Ambac’s own misconduct may have helped bring collapse about.

    Ambac ‘secretly lowered its underwriting standards to allow guarantee of billions of dollar of high risk mortgage-realated securities without adequately disclosing acceptance of greater risk — FIDUCIARY.

    Ambac consistently misreprsented deteriorating portfolio risk, consistently posting small reserves, and mark-to-market write downs indicating a healthy portfolio.

    In fact mortgage-backed securities showing significant delinquencies and risk of loss that would crippple its capital base.

    Plaintiff’s experts testimony allowed to validate findings of misrepresentations with evidence.MEMO

    SMOKING GUNS? WIll there be any for US against US?
    and US to bring S&P to its knees?
    US & S&P how will they both escape the passive argument they contributed to their own demise and who of the ‘gang’ will claim and produce evidence for who? All claiming “hey, the whole economy tanked” argument … Will AMBAC case law be authority or persuasive?

    While Ambac did what it was told S&P, MOODY’s ‘blessed’ AAA….

    HOW SIMILAR will S&P’s story be?

    S&P ratings based on ‘insurers’ and ‘institutional investors who owned the certificates’ and the sample of look alike loans that would produce revenue as assets.

    Ambac Financial Group monoline insurer providing protection against credit risk. FIDUCIARY.

    Traditionally the company insured municipal bonds, and began providing default protection for structured financial products such as residential mortgage backed securities (RMBS) and collateralized debt obligations (CDO). In which Ambac drastically lowered its underwriting standards by the start of the Class Period so that it could guarantee billions of dollars of high risk securities in order to meet aggressive revenue targets.

    These critical changes—which were not disclosed to investors—had a catastrophic effect on the quality and performance of Ambac’s portfolio of residential mortgage-backed securities (“RMBS”) and collateralized debt obligations (“CDOs”) supported by RMBS.

    (the same story true of every insurer). The cascading effect of the AAA ratings by the insurer, and AAA ratings of Institutional Investors assured collapse of economy each given the (S&P Stamp of Approval) (Moody’s Stamp of Approval) ….

    January 16, 2008 Ambac’s CEO who had assured investors that Ambac’s mortgage portfolio was not exposed to any material losses – disclosed before the next quarter the truth?:

    (a) $5.4 billion in “mark-to-market” write-downs of its CDO exposures; (b) a staggering $1.1 billion of CDO impairments;
    (c) a dramatic tripling of its RMBS loss reserves;
    (d) a 67% reduction in its dividend (in order to preserve capital); and (e) its CEO’s unexpected “resignation.”

    Write-downs alone wiped out the Company’s previously reported earnings going back to 2002. Loss of AAA rating guaranteed bankruptcy and preselling of assets all parties shuffelling off to buffalo.

    What recovery did the Plaintiffs, the Public School Teachers’ Pension and Retirement Fund of Chicago, the Arkansas Teachers Retirement System, and the Public Employees’ Retirement Systems of Mississippi, and Painting Industry Insurance and Annuity Funds, in the case against Ambac Financial Group, Inc. (“Ambac”) and certain officers, directors, and underwriters (collectively, “Defendants”) arising out of materially false and misleading statements made by Defendants concerning the underwriting standards and portfolio performance of certain mortgage-related exposures during the Class Period.

    -’ allegations largely related to the company’s provision of insurance coverage for collateralized debt obligations.

    Plaintiffs allege, defendants failed to disclose that the company lacked internal controls sufficient to ensure that the company’s standards for underwriting CDOs were adequate, and that the company had a far greater exposure to CDO-related losses and defaults than the company had previously disclosed.

    in rejecting the “hey, the whole economy tanked” argument is important.

    Separate securities suit was filed in December 2008 in the Southern District of New York against Ambac and certain of its directors and officers on behalf of invertors in the company’s Structured Repackaged Asset-Backed Trust Securities (STRATS), as reflected here.

    The STRATS lawsuit, which proceeded separately from the consolidated case, alleged that the defendants had issued false and misleading statements concerning Ambac’s financial results and operations.

  2. I’ve never traded stocks in my life, but isn’t the whole “upgrade, downgrade” BS all just a way for someone somewhere to make money by manipulation??? So, S&P downgrading is making someone money…hmmm…who could that be??? They made a few people very rich and destroyed America in the process with their BS AAA ratings, now let’s see who is benefiting with the “downgrades”…

  3. There is enormous power in this tiny sector comprising of only a few rating agencies. If their opinions are so important their activities need to be regulated somehow. It really doesn’t feel reasonable that the fiscal fate of so many countries rests on the analytical verdict of three private-sector firms!

  4. What does it mean if the credit ratings of the country and states may go down in the future? S& P lowered the credit rating of CA to AA from AAA.

    What would this all amount to when it comes to banks? Will there be more bank closures?

  5. At the ‘SEC’ documents can be destroyed how?
    There are processes and procedures for the handling of documents and details on when documents may be destoryed, and to request documents for destruction. Who can report the facts on the processes over hte documents destroyed.

  6. Good one MD

  7. “The Securities and Exchange Commission has also been investigating possible wrongdoing at S.& P., according to a person interviewed on that matter, and may be looking at the other two major agencies, Moody’s and Fitch Ratings.”…….

    Really?????? They destroyed 9000 Files!!!


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