Justice Department targets S&P
The Justice Department has filed civil charges against Standard & Poor's over mortgage securities it rated in the run-up to the 2008 financial crisis, setting up a high-profile showdown between the government and the much-maligned ratings industry.
In a lawsuit filed late Monday in the U.S. District Court for the Central District of California, the Justice Department alleges that S&P knowingly executed a scheme to defraud investors between September 2004 and October 2007 in its ratings of mortgage securities that were tied to subprime mortgages.
The department argues that in order to attract more business from investment banks that put together these types of securities, S&P was knowingly giving out favorable ratings to these products to the detriment of the investors who bought them.
"Put simply, this alleged conduct is egregious — and it goes to the very heart of the recent financial crisis," said Attorney General Eric Holder said in a statement Tuesday. "Today's action is 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."
The Justice Department said that state attorneys general from California, Connecticut, Delaware, the District of Columbia, Illinois, Iowa and Mississippi have filed or plan to file similar lawsuits.
New York Attorney General Eric Schneiderman is also expected to file a lawsuit.
The lawsuit is a long-awaited major challenge from the government against a ratings agency investors relied on during the housing bubble and the ensuing 2008 financial meltdown.
The Obama administration has been under fire for not being more aggressive in pursuing cases against Wall Street firms that played a role in the financial crisis that led to the Great Recession.
The lack of action against credit rating firms had not gone unnoticed on Capitol Hill, and many lawmakers welcomed the move against S&P this week.
"I want to commend the Justice Department for taking long overdue action to hold S&P accountable for its conduct leading up to the 2008 financial crisis," Rep. Maxine Waters (D-Calif.) said in a statement Tuesday.
But by choosing to file civil rather than criminal charges, Justice disappointed critics who argue it needs to start using the threat of jail time to prevent future misdeeds.
"It seems the Justice Department is trying to sue the country's way out of the fiscal crisis instead of bringing cases that might have a real deterrent effect," Sen. Chuck Grassley (R-Iowa) said in a statement. "Most civil suits are simply the cost of doing business and aren't enough. Unfortunately, this appears to be another instance of the civil case-only, ‘too-big-to-jail' mentality at the Justice Department."
On Monday, before the lawsuit was filed, S&P said DOJ would be unjustified in pursuing a case because the firm based its assessments on the same data and information as other companies and government officials that also concluded that trouble in the housing market would be fleeting.
"A DOJ lawsuit would be entirely without factual or legal merit," S&P said.
The company said it "deeply regrets" that the ratings did not anticipate the rapid collapse in the housing market and pointed out it did downgrade hundreds of subprime mortgage bonds in 2007.
"With 20/20 hindsight, these strong actions proved insufficient — but they demonstrate that the DOJ would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith," S&P said in the statement.
DOJ is bringing its lawsuit under the Financial Institutions Reform, Recovery and Enforcement Act, which requires a lower burden of proof for the government and allows for larger penalties against fraud.
DOJ is seeking the maximum fines allowed under this law.
"We believe conservatively that S&P's actions make it liable for more than $5 billion in civil penalties," Acting Associate Attorney General Tony West said at a news conference announcing a lawsuit.
The company argued on Monday that courts have dismissed a number of cases that challenge a ratings agency's opinions of creditworthiness and the firms have often portrayed the defense of their work as a First Amendment issue.
"The First Amendment protects a lot of things; it does not protect saying one thing and doing another. It does not protect issuing ratings that you know are inflated," West said. "Those are two basic allegations in this lawsuit."
Credit rating agencies came under fire following the financial crisis because they provided AAA ratings to mortgage-backed securities that were filled with subprime loans that went sour as the housing crisis commenced.
The collapse of the mortgage-backed securities market was a prime contributor to the broader financial crisis.
Several members of Congress questioned whether the rating agencies had enough independence because they are paid by the companies whose bonds they rate.
But efforts, led by Sen. Al Franken (D-Minn.), to dramatically change the way the industry works — by having an independent entity decide which company will rate which bonds — failed to make it into the 2010 Dodd-Frank financial oversight law.
"I haven't yet seen the details of this lawsuit, so I can't offer specific comments, but for anyone who knows the key role that the credit rating agencies played in the financial meltdown, it shouldn't come as a surprise that the Department of Justice is pursuing legal action," Franken said in a statement Monday.
The law does require the SEC to write rules to better police the industry, and banking regulators were required to strip any reference to the firms' rating from the rules they use to enforce things such as bank capital standards.
Separately, the ratings firms have been at odds with Treasury Department and Congress over their assessments of government's creditworthiness, given the ongoing fiscal battles in Washington.
S&P made few friends on Capitol Hill in 2011, when it issued the first-ever downgrade of the U.S. debt rating following the 2011 debt ceiling standoff.
In the downgrade, the agency said that by threatening to not pay its debts — as well as by running large deficits — the federal government revealed itself a less reliable borrower.
But lawmakers balked, arguing the agency had damaged its credibility by giving high ratings to mortgage-backed securities that eventually collapsed en masse amid the subprime mortgage crisis.
The other two major credit agencies — Moody's and Fitch Ratings — did not downgrade the U.S. debt, but both have warned that ongoing budget impasses have put their perfect score for the U.S. credit rating at risk.
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