February 12, 2013

My last column on the federal suit against the bond-rating agency Standard & Poor’s drew some critical reactions that are worth sharing with readers. In the column, I argued that S&P, which badly erred in rating bonds tied to home mortgages, was being made a scapegoat for the financial crisis. As is well-known, this crisis — with some exceptions — was not foreseen by government officials, economists or bankers. S&P’s sins, I wrote, stemmed more from this over-optimism than from a deliberate effort to mislead markets.

One skeptical response came from an economist I know and respect. He wrote that although he “largely” agreed with the column, he thought I “let S&P off too easily.” Here’s the crucial passage in his e-mail:

“The rating agencies have historically done a pretty good job with their corporate ratings, but they have a real conflict of interest on securitizations [the bundling of many separate loans or bonds into a larger bond]. On corporate bonds ... their fees are pretty much the same no matter what the rating. On securitization, an unwillingness to give an AAA rating to a large enough tranche of the offering would kill the transaction. So, the agencies become effective partners in structuring the transactions and had a real incentive to take an encouraging approach.”

I think this is probably true. The Department of Justice argued, on the basis of internal company e-mails and documents, that S&P delayed altering its risk models in ways that would have lowered ratings for mortgage-related bonds. The crux of the case against S&P is that its ratings were distorted by its business interests and were not “objective” and “independent” as promised.

But these erroneous and self-serving judgments could as easily have been influenced and rationalized by the euphoria surrounding housing in the boom years. As I noted, there was a broad belief — which now appears foolish — that home prices would rise for the foreseeable future. If that had happened, the housing “bubble” would never have burst and the financial crisis never would have occurred. I also put stock in the fact that many issuers of mortgage-backed securities (Citigroup, Merrill Lynch, etc.) invested heavily in them. They knew the quality of the underlying mortgages as well as anyone; yet, they kept them, presumably because they believed the securities were good investments.

By contrast, the Department of Justice alleges that S&P “knowingly and with the intent to defraud” awarded excessive ratings to the mortgage-backed securities. This is a much stronger charge than simply accusing S&P of erring on the side of self-interest. The complaint offers e-mails and other internal documents in support of this conspiracy, but I found the evidence weak. Most organizations have dissenters from official policy, and some will disagree in colorful language. And remember: S&P hasn’t yet issued a detailed rebuttal based on its own reading of the e-mails and documents.

Another interesting reaction came from a reader — unknown to me — who works in the financial services industry. My column, he said, “leaves out something vital.” The complaint against S&P, he said, “could also serve to punish [S&P] for downgrading the federal credit rating in 2011 — note that Fitch and Moody’s [the other main rating agencies] did not follow suit in 2011 and are not being sued.”

The administration, of course, admits no such thing. The two events (the suit and S&P’s downgrade of Treasury debt) may be unconnected. But it’s clear from this e-mail and other commentary that many people in the financial community believe the two are related, even if they can’t prove it. They think S&P is a victim of retaliation.

Read more from Robert Samuelson’s archive.