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Will S&P’s penalty for too-rosy mortgage securities ratings send a message?

February 3, 2015 at 6:35 PM EDT
While not admitting wrongdoing, Standard & Poor’s Financial Services agreed to pay almost $1.4 billion to settle allegations by the Justice Department that credit ratings for high-risk mortgage securities mislead investors before the 2008 financial crisis. Judy Woodruff discusses implications of the penalty with Mississippi Attorney General Jim Hood and Lynn Stout of Cornell University.
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JUDY WOODRUFF: More than six years after the financial crisis hit the economy with full force, the government has finally closed one of its major cases against a key player.

The Justice Department’s settlement with Standard & Poor’s centered on credit ratings the company awarded during the lead-up to the housing bust. Some observers and experts have long argued that rosy ratings of troubled mortgage securities helped inflate the market.

For its part, S&P didn’t admit to criminal wrongdoing in the settlement.

But, at a press conference, Attorney General Eric Holder laid out part of what the company conceded.

ERIC HOLDER, Attorney General: 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.

As S&P admits under this settlement, company executives complained that the company declined to downgrade underperforming assets because it was worried that doing so would hurt the company’s business. Now, while the strategy may have helped S&P avoid disappointing its clients, it did major harm, major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.

JUDY WOODRUFF: The settlement included attorneys general from 19 states and the District of Columbia.

Jim Hood, the attorney general of Mississippi, was there today. He joins me now, along with Lynn Stout. She is a professor of corporate and business law at Cornell Law School.

We welcome you both.

Attorney General Hood, what are some examples of what Standard & Poor’s did that they shouldn’t have done? 

JIM HOOD, Attorney General, Mississippi: Well, they made misrepresentations.

They portrayed themselves as if they were pure as the driven snow and that they were making independent evaluations of these mortgage-backed securities that the banks were running through. They were making three the four times as much for these evaluations, and they kept, you know, repeating over and over that they were independent in their evaluations.

And they weren’t. And what we found out, that that was a violation of the state’s Unfair and Deceptive Trade Practices Act. Our consumer protection laws came into play. And so Connecticut initially filed first. Richard Blumenthal, who is senator now, was the attorney general then, called me and encouraged me to file in the — we filed second.

We had a long, drugged-out battle. But when the federal government and other states joined in, we moved pretty quickly toward settlement.

JUDY WOODRUFF: Lynn Stout, how much were these companies getting out of this, not just Standard & Poor’s, but the companies that were producing these mortgage-backed securities?

LYNN STOUT, Cornell University: Well, it was, in fact, a relatively new line of business for the ratings agencies, rating these mortgage-backed securities.

And it wasn’t necessarily the majority of their business, but it was a very profitable sector. And, obviously, they were trying to grow it.

JUDY WOODRUFF: But money was being made is the point.

LYNN STOUT: Oh, yes. Yes. No, they were definitely making money, especially in the short term.

In the long term, it look like it’s going to cost them far more. The settlement, depending on how you calculate it, is going to amount to either one or twice the annual profits of McGraw-Hill Financial, which is the parent company of S&P.

JUDY WOODRUFF: And I want to ask you both about that in just a minute.

But at the time, what was the connection, Jim Hood, between what S&P did to the financial collapse?

JIM HOOD: Well, they made it easy for the banks to package these bogus instruments.

Warren Buffett said he didn’t understand these instruments. And if he didn’t, many didn’t. And they didn’t have the capability really to properly analyze these instruments, yet they were being paid three to four times as much. In fact, I think Standard & Poor’s was making 40 percent of what they were making at a rate of about $1 billion a year — 40 percent of that was coming from these evaluations.

Moody’s was even higher. The state of Mississippi and Connecticut sued Moody’s as well. They were not part of this settlement. But they were making about 50 percent of their income from these evaluations.

JUDY WOODRUFF: And, Lynn Stout, we know that Standard & Poor’s came back and said, no, this is not true, we are not guilty. The Department of Justice took — first brought this case two years ago. Why has it taken so long?

LYNN STOUT: These big cases against financial institutions always take a long time.

The reality is, these big banks and financial institutions, including ratings agencies, they’re very big, they’re very profitable. They can afford to spend a lot of money on lawyers. And, as a rule, government authorities are generally pretty outgunned, or at least outlawyered, in these cases.

And so it’s very easy to drag them out to, to send up a lot of smoke to make it hard to figure out what is going on. And they do tend to fight them tooth and nail, honestly, in the hopes they can just tire the government out.

JUDY WOODRUFF: And, in fact, Attorney General Jim Hood, originally, what S&P was saying was that the Department of Justice was coming after them, the government was coming after them because S&P had downgraded U.S. government debt back in 2011.

What happened to that argument?

JIM HOOD: They had to detract that. That was very important to both attorneys general and the federal government, because it made it look like government was that petty to take that type of action.

In fact, the state of Mississippi had filed suits. We filed in 2011 against Standard & Poor’s on this theory of consumer protection. Initially, we had sued the banks on securities and the credit rating agencies. They were dismissed on First Amendment grounds.

They said, well, we can puff. We can just say things. But when we began to shift to this theory of violation of our consumer protection acts, unfair, deceptive trade statements, then that theory, they couldn’t get that one dismissed. And that’s when they paid $1.375 billion.

JUDY WOODRUFF: And, Lynn Stout, you were just saying that, for Standard & Poor’s, that’s a significant penalty?

LYNN STOUT: I think it is. This is going to really hurt them. A couple years’ profits is a big loss.

And that’s actually I think in the long run the only effective way to try and prevent these sorts of fraudulent cases in the future, is you have to hit the institution in its pocketbook. That’s what really is the area where it can feel the pain. So, even though there was no agreement of criminal activity, I think this is going to be a pretty effective penalty.

JUDY WOODRUFF: And just quickly, Jim Hood, what about the people who were originally harmed by this?

JIM HOOD: Those people who lost their homes as a result of this, they don’t really gain anything from this. This is — this will go back to our states to help pay for some of the programs that we have implemented to try to keep people in their homes.

But, you know, this was just sent to send a message. This was a penalty. And it hurt bad enough that it will affect — hopefully, in the future, deter this type of conduct. Now, under regulations passed in August, the SEC has a duty to regulate and not let this occur in the future.

JUDY WOODRUFF: Attorney General Jim Hood from Mississippi, Lynn Stout at Cornell, we thank you both.

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