S&P $1.38 billion fine doesn’t fix credit ratings’ fundamental conflict
WASHINGTON – More than six years after the financial crisis struck, credit rating giant Standard & Poor’s will be paying a hefty $1.38 billion penalty for its role in fueling the subprime mortgage meltdown. But that doesn’t mean it can’t happen again.
S&P’s settlement announced Tuesday with the U.S. government, 19 states and the District of Columbia marks a public chastening of a major credit rating agency accused of knowingly overrating toxic mortgages that ignited the crisis. S&P and its competitors are crucial gatekeepers that can affect a company’s or government’s ability to raise or borrow money. In the aftermath of the crisis, federal regulators have imposed some changes on how the rating agencies conduct business.
Yet the fundamental conflict of interest at the heart of the rating agencies’ business remains intact: They continue to be paid by the companies whose securities they rate.
“This doesn’t fix anything,” said Janet Tavakoli, the president of Tavakoli Structured Finance and a former investment banker. “This is just a traffic ticket.”
Tavakoli cites a number of problems, including payments that companies and banks make to the agencies for ratings, as well as flawed statistical methods. The government should go further and strip the big rating agencies’ national licensing for rating complex securities, she suggested.
The process for companies and rating agencies is akin to having a pitcher choose the umpire, critics of the industry say, and it puts pressure on the agencies to award better ratings in order to secure repeat business.
That’s exactly what the government asserts S&P did in ratings on billions of dollars of securities that it issued from 2004 through 2007. The settlement resolves a court fight that began with a Justice Department lawsuit two years ago. S&P was accused of failing to warn investors that the housing market was starting to collapse in 2006 because doing so would hurt its ratings business.
Half the amount New York-based S&P is paying, or $687.5 million, will go to the 19 states and the District of Columbia.
Under the agreement, S&P acknowledged that it issued and confirmed positive ratings despite knowing that those assessments were unjustified and in many cases based on packages of mortgages that it knew were likely to default.
“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 at a news conference Tuesday.
S&P also agreed to retract its earlier allegation that the government had brought the action in retaliation for its downgrade of the United States’ credit rating in 2011, a concession that Holder said was personally important to him.
The three big rating agencies – S&P, Moody’s Investors Service and Fitch Ratings – have been blamed for helping fuel the 2008 crisis by giving strong ratings to high-risk mortgage securities. The ratings made it possible for banks to sell trillions of dollars’ worth of those securities. S&P rejects the idea that the rating agencies’ current business model is particularly vulnerable to conflicts of interest.
It makes the case that having companies pay for ratings enables those assessments to be made widely available to the public, free of charge, thereby promoting greater efficiency in the bond markets. “Public disclosure of our ratings to a broad audience of market participants means our opinions are subjected to market scrutiny every day,” it says.