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S&P’s seal of approval for toxic securities lands firm in court

The Washington Post, AP

The largest U.S. ratings agency, Standard & Poor’s, in July 2007 was considering whether to downgrade a range of mortgage bonds that had earlier gotten the company’s seal of approval. Pressure was increasing inside the firm to reveal the toxic nature of these securities.

But there was a problem, according to an email exchange between an S&P analyst and an investment banker. “Leadership was concerned of pissing off too many clients,” wrote the S&P analyst.

The response from the investment banker: “We pay you to rate our deals, and the better the rating the more money we make?!?! Whats up with that? How are you possibly supposed to be impartial????”

The exchange was detailed in a 128-page lawsuit unveiled by the U.S. Justice Department on Tuesday that accused S&P of deliberately awarding safe grades to toxic mortgage securities so the company could increase its profits.

Government attorneys said that S&P’s actions in 2007 during the runup to the global financial crisis make it liable for at least $5 billion in damages, making the case one of the highest-profile attempts so far by the federal government to prosecute those responsible for the country’s economic meltdown four years ago.

“This alleged conduct is egregious — and it goes to the very heart of the recent financial crisis,” U.S. Attorney General Eric Holder said at a news conference.

The lawsuit against S&P is also the first major enforcement action against one of the nation’s big ratings agencies, which have been frequently blamed for playing a major role in causing the U.S. financial crisis.

A coalition of 14 states and the District of Columbia filed lawsuits Tuesday against S&P alongside Justice. They include Arizona, California, Illinois, Iowa and Pennsylvania.

Justice lawyers are charging the company with bank, mail and wire fraud. The case was brought under a law passed in 1989 in the wake of the savings and loan crisis that allows Justice to seek civil penalties equal to how much money was lost by financial institutions.

S&P, which is owned by McGraw-Hill, released a statement Tuesday saying the lawsuits were “meritless,” adding, “Claims that we deliberately kept ratings high when we knew they should be lower are simply not true.”

The firm has argued it was not the only ratings agency that gave top-notch ratings to the complex financial products in question during this period — and that others, including U.S. government officials, missed the coming housing bust as well.

“Although we deeply regret that these 2007 CDO ratings did not perform as expected, 20/20 hindsight is no basis to take legal action against the good-faith opinions of professionals,” said the company, referring to collaterilized debt obligation securities.

The actions of S&P and other ratings agencies such as Moody’s have drawn controversy because they issued top ratings for toxic securities whose values were based on residential mortgages. These ratings caused investors to think the products were safe, but when housing prices nose-dived the securities lost their value, nearly wiping out the finances of the biggest banks in the country.

Many experts have argued that the ratings agencies had a conflict of interest since they were being paid for their analysis by the banks whose products they were rating.

Justice lawyers argue that S&P is not being blamed for failing to see the drop in housing prices.

“It’s not about predicting the future,” Tony West, acting U.S. associate attorney general, told a press briefing. “It’s really about promising to do one thing and doing something else.”