The Standard & Poor’s rating agency has agreed to pay $1.5 billion to the US and various states to resolve lawsuits over its rating of mortgage-backed securities [MBS] that contributed to the Great Recession. “On more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised,” Attorney General Eric Holder said in announcing the settlement. S&P admitted no wrongdoing, and Mr. Holder will leave the Justice Department without a single indictment despite the clear evidence of massive fraud.
The S&P case is important because the rating agencies were giving top ratings to transactions that were anything but Aaa-worthy. Two years ago, Andrew Ross Sorkin and Mary Williams Walsh wrote about the collateralized debt obligations that lay at the heart to the federal suit.
The case against S.& P. focuses on about 40 collateralized debt obligations, or C.D.O.’s, an exotic type of security made up of bundles of mortgage bonds, which in turn were composed of individual home loans. The securities were created at the height of the housing boom. S.& P. was paid fees of about $13 million for rating them.
Prosecutors have uncovered troves of e-mails written by S.& P. employees, some of them expressing strong concern about the way such securities were being rated. The firm gave the government more than 20 million pages of e-mails as part of its investigation, the people with knowledge of the process said.
In hindsight, it is clear that S&P, and the other rating agencies Moody’s and Fitch, got quite a bit wrong in rating MBS deals. The question is whether they did so knowingly. The evidence, while not formally presented in a court of law, suggests that there were analysts blowing whistles that top management refused to hear.
However, the rating agencies function is merely to provide third-party perspective to a credit decision. Theirs is a business of garbage-in, garbage out. To understand why one can give them the benefit of the doubt readily, one must understand exactly what they were being asked to rate.
Mortgage-backed securities are essentially bonds backed by the revenue stream from a pool of mortgages, either residential or commercial. By bundling loans together and selling off the obligation, banks can originate loans in large volumes without undermining their financial stability. At the same time, investors get a fairly secure debt instrument in which to invest. The trouble comes when the quality of the underlying loans deteriorates or is mis-stated in the first place.
While there are many borrowers who took out loans they could never repay, there are equally bankers who extended credit when they should not have. These are poor business decisions, and while they are deplorable, they are not criminal.
What was criminal was the “robosigning” of mortgage and MBS-related paperwork by the banks. Robosigning was bank policy in many institutions, whereby required signatures were given without the due diligence needed. The papers were simply presumed to be correct in all details. This is, of course, fraud. Moreover, it is not just fraud but a conspiracy of fraud, and it even violates the RICO Act.
The ratings agencies may be guilty of ignoring their due diligence obligations, but the banks simply lied in some cases. And Eric Holder is letting everyone who helped crash the global economy walk. His shining civil rights record doesn’t begin to cancel out that dereliction of duty.