By Charles R. Morris
NEW YORK Feb 5 The credit rating agency,
Standard & Poors, announced Monday that it was the target of a
civil lawsuit by the Justice Department for its actions in
rating the complex securities that played a major role in the
2008-2009 financial collapse. The company also said that it had
not been apprised of the details. It is interesting that the
other two major rating agencies, Moody's and Fitch made no
There is much that all the agencies should worry about. What
is publicly known - and it is a great deal - was laid out in the
two-year Senate investigation led by Senator Carl Levin
(D-Mich.), which ended with the release of a final report in
The committee staff laid out a formidable case. As early as
2004 and 2005, and increasingly by 2006, the email chatter among
the rating agency staffs suggested they were expecting a crisis.
One email said: "This is frightening. It wreaks of greed,
unregulated brokers and 'not so prudent' lenders." Staff
analysts asked why the regulatory agencies hadn't "come down
harder on these guys." One wrote worriedly about the possibility
of "another banking crisis."
One damning sequence occurred in spring, 2007. Early that
year, it became clear that the subprime mortgage market was in
serious trouble. Two major subprime issuers failed in December
2006, and in the first quarter of the new year, another 20
failed, including the giant New Century. This was also the
period, as we now know, that Goldman Sachs embarked on an
aggressive internal clearing of its inventory, or "The Big
Short" as it was called, which was largely accomplished by
selling to greater fools.
But for the most part, Wall Street and the credit agencies
shrugged off the worries and carried on with business as usual.
The agencies issued triple-A ratings even on booby traps like
the security that Goldman devised for the hedge fund manager
John Paulson, so he would have a $1 billion plus security that
he could bet against with confidence in its shakiness.
Yet, mysteriously, the tempo of work at the credit agencies
changed radically in July. In the first week, S&P quadrupled its
output of ratings, and Moody's doubled theirs. The volumes of
issuances had not been increasing, so this step up is output in
extraordinary. These were extremely complex securities, with
intricate shifts in the credit-worthiness of one part of the
structure based on the prices of another. Often, the value
shifts were non-linear. Instead of a decline that followed a
reasonable curve, for example, there could be leaps or plunges
in value that appeared out of proportion to the triggering
event. S&P analysts had complained all year about their
stretched staffing, yet that week they pushed out 300 new
ratings a day.
Then in the very next week of July, both agencies suddenly
switched to down-grading - and doing it violently. Some 900
instruments were downgraded by one or both agencies, usually by
several notches, and often driving AAA-rated securities all the
way down to junk. Hundreds more securities were placed on credit
No one had ever seen anything like it. The downgrading
continued, more as a series of eruptions rather than a smooth
curve. One set of coordinated downgrade actions in early 2008 by
S&P involved a half-trillion dollars of securities.
When senior ratings agency executives were later interviewed
by the Senate committee, they professed themselves to be
clueless. He was told the downgrades were coming, one said, but
he wasn't told why - and presumably didn't think to ask, even
about an event that could destroy their core business.
Though it may be un-provable, it's obvious what happened.
Aware that their ratings were growing more and more
preposterous, the agencies finally adjusted their standards and
set a date to start using them. Then with utter cynicism, they
pushed through as much work in process as they could before the
change took effect, so as not to lose their fees.
In other words they used ratings criteria that they knew
were wrong. And it also looks as if they were colluding at the
The credit agencies, it was always clear, were the pawns of
the banks, which accounted for the lion's share of their
revenue. The agencies' stock prices were soaring along with
their fees, and managers and executives were getting rich. It's
just another example of how easily strict codes of ethics
crumble at the scent of money.
The executives look like they topped off their spinelessness
with cravenness. When they were called to account by
investigators, they cravenly sheltered under the pretense that
they were just another species of journalist, making "free
speech" comments, with no intent to offer guidance to investors.
A civil action is a de minimis response. But at least it will
put their shameful behavior back in the spotlight.