S.&P. to Pay $1.38 Billion for Once Rave Ratings of Toxic Mortgages

February 3, 2015
by Jason M. Breslow Digital Editor

(AP Photo/Henny Ray Abrams)

In the build-up to the financial crisis, ratings agencies like Standard & Poor’s, Moody’s and Fitch issued high grades to billions worth of toxic mortgage-backed securities — investments that banks created and then paid them to rate.

“Their ratings helped the market soar and their downgrades … wreaked havoc across markets and firms,” a federal commission charged with investigating the crisis concluded in 2011.

On Tuesday, those actions came back to bite S.&P. In a first-of-its-kind settlement for a ratings agency, the firm agreed to pay $1.38 billion to the Department of Justice and 19 state attorneys general and the District of Columbia over allegations that it knowingly understated the risk behind many of the financial instruments that caused the meltdown.

Under the terms of the deal, S.&P. will pay roughly $687 million to the U.S. government, with the remainder to be divided by the states involved in the case. But as in similar settlements with the nation’s largest banks, S.&P. was not forced to admit wrongdoing, a clause that has repeatedly irked critics of the government’s legal response to the crisis.

Despite no admission of guilt, S.&.P. offered several concessions in a statement of facts agreed to by both sides in the agreement. The ratings giant acknowledged that its rating models were shaped in part by business concerns. It also acknowledged that it continued to issue positive ratings on mortgage securities despite growing awareness within the firm that the underlying mortgages were increasingly turning sour.

Such overly rosy ratings contributed to at least $5 billion in losses by federally insured financial institutions, according to the Justice Department.

“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 a statement.  “While this strategy may have helped S.&P. avoid disappointing its clients, it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.”

In a separate statement, the company’s parent firm, McGraw Hill Financial, emphasized that, “the settlement contains no findings of violations of law,” and that it entered into the agreement in order “to avoid the delay, uncertainty, inconvenience, and expense of further litigation.”

With the agreement, S.&P. becomes the only ratings agency to settle government charges over the financial crisis. The industry has otherwise emerged from the crisis largely unscathed, with firms continuing to operate under a compensation model that allows banks to pay the very firms that are rating them. In 2011, a Senate report called that model “a conflict of interest problem that results in a race to the bottom — with every credit rating agency competing to produce credit ratings to please its paying clients.”

The Dodd-Frank financial overhaul expanded oversight of ratings firms by establishing an Office of Credit Ratings within the Securities and Exchange Commission, and this past summer, the SEC adopted a series of measures designed to enhance transparency inside the industry.

Still, critics warn that without wholesale reform to how ratings agencies are paid, the risk of firms putting their business interests ahead of sound ratings will never completely go away.

“Essentially you have the same ingredients that led to the last crisis latent and in the system still today,” said Phil Angelides, the former California state treasurer who led the bipartisan Financial Crisis Inquiry Commission, in an interview with FRONTLINE. “These things tend to manifest themselves. What happens is that 10, 15 years down the road, people forget the crisis, and if the structure isn’t different, the fact is that the same kinds of problems can arise again and likely will arise in some form.”

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