All those associated with the sub-prime loans scandal that led to the global financial crisis of 2008 have paid the price one way or another. Banks and financial institutions have taken large write-offs on their balance-sheets, causing valuations to fall. Investment banks either went belly up or accepted ignominious lifelines from healthier peers. Investors have seen their lifetime savings wiped out and governments have been voted out of power. Indeed, the global economy — including the economies of countries which were in no way involved with the misdemeanours of the U.S. housing and financial sector — is still paying the price. Yet, ratings agencies, one of the primary villains of the sub-prime loans-driven financial crisis, had largely escaped punishment. That was until Monday when the U.S. government slapped a lawsuit against the foremost of the Big Three ratings agencies — Standard & Poor’s — seeking $5 billion in punitive damages for defrauding investors. More than the financial damage that this lawsuit will cause — and it is potentially serious, given that the revenues of The McGraw-Hill Companies, of which Standard & Poor’s is a division, were just $6.24 billion in 2011 — it is the blow to S&P's reputation that will hurt more. From the suit filed by the Department of Justice (DoJ) it is clear, despite protestations from S&P, that the agency assigned dubious ratings to complex financial instruments with the outright intent to defraud investors.
From September 2004 through October 2007, says the suit, S&P “knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors” in certain mortgage-related securities. S&P, the suit says, falsely claimed its ratings “were objective, independent, uninfluenced by any conflicts of interest.” At the height of the sub-prime loans frenzy, ratings agencies merrily dished out top-notch scores to esoteric financial instruments such as collateralised debt obligations (CDO) which were nothing but a bundle of mortgage-backed securities made up of dubious housing loans. Emails accessed by the DoJ clearly show that ratings analysts in S&P were uncomfortable at rating substandard loans as prime but had to submit to business pressures. The evidence clearly points to intentional fraud. Interestingly, though Moody’s and Fitch, the other two of the Big Three, were equally guilty of assigning dubious ratings, the U.S. government has gone after S&P alone for now, prompting talk that it is revenge for the downgrade of the U.S. from its stellar ‘AAA’ by S&P in August 2011. Maybe so, but it still cannot detract from the merits of the case. S&P played a pivotal role in precipitating the sub-prime crisis and it needs to be called to account.
