In a possible major precedent, the US Justice Department is suing Standard and Poor’s over ratings of subprime mortgage securities. S&P is alleged to have conducted ratings management to the advantage of issuers.
The list of incidents cited by AAP in the Telegraph is revealing:
The suit cited S&P's top-grade ratings of dozens of mortgage-based collateralised debt obligations (CDOs) issued in early 2007 that were in default within one year, some within six months.
The defaults dealt billions of dollars in losses to financial institutions insured by the US, some of which collapsed in the 2008 crisis and others, like Citigroup, forced to seek a government bailout.
"At the very least, we believe conservatively that S&P's actions make it liable for more than $5 billion in civil penalties," said US Acting Associate Attorney General Tony West.
… S&P's modus operandi was to "limit, adjust and delay those updates" to favour issuers and "maintain and grow S&P's market share and profits", the complaint alleges.
The inference is that the market was given out of date information regarding the state of the securities, leading first to the subprime crash and the implosion of the US housing industry with gigantic drops in housing prices, followed by the massive stock market crash in 2008-9. The combined crashes led to unheard-of losses in the US economy and chronic unemployment.
The suit, filed in California and backed by a number of state governments, accused the credit rater of knowingly inflating its ratings on CDOs and residential mortgage-backed securities in 2007 in order to win revenue from issuers.
S&P was specifically charged with wire fraud, mail fraud and financial institution fraud.
S&P categorically denies the charges. Other ratings agencies have not been charged.
This lawsuit has major ramifications for the financial industry. Ratings are the currency of investment quality evaluation. They’re supposed to be based on a critical analysis of asset values. Many of the mortgage securities turned out to be worthless, after being touted as viable financial products. Like the “junk bonds” of the 1980s, they became no more than bits of paper.
The net effect on private and institutional capital was disastrous. Even those investors not directly exposed to mortgage securities and other derivatives lost heavily as capital was drained out of the markets. Debt-related financial products became negative assets.
The effect on the banking sector was arguably as bad or worse. 442 US banks collapsed as the discrepancies between book values and real values dragged them under. Just about anyone who had money in any form of investment, anywhere on Earth, was affected.
This suit embodies a range of financial practices and the ultra-ugly sides of a toxic, totally irresponsible culture which are generally held to be responsible for America’s Titanic-like impact against the icy realities of the markets. These practices are also the cause of the near-total disembowelling of Middle America’s capital and savings.
Whoever’s guilty, this case has to create the legal framework to make sure that sort of disaster can never happen again. With all due respect to the process of law, there aren’t too many truly innocent parties in Washington or on Wall Street.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of DigitalJournal.com