Quelle Surprise! Standard & Poor’s Execs Diddled in Mortgage Bond Ratings (Updated)

Louise Story at the New York Times reports that the SEC is looking into whether it has grounds to file suit against the ratings agency Standard & Poor’s for publishing higher ratings on bonds than the analysts had recommended. The article reports that the agency has found instances where executives overrode analyst judgement to award higher ratings on mortgage bonds that were later downgraded and produced investor losses. The piece indicates that the SEC has found instances of this sort of misconduct; the question seems to be whether it took place often enough to make a case.

From the Obama administration’s standpoint, it must seems rather unfortunate that the SEC has decided to go after S&P just as Matt Taibbi has called attention to the fact that the agency has organized its affairs so as to help it avoid seeing all but the most egregious misconduct. Readers will point out that any case would be politically motivated, but those who live by the sword should be prepared to die by the sword. S&P’s downgrade of the US bears all the hallmarks of reflecting the agenda of McGraw Hill chairman and CEO Terry McGraw. Among other things, he is head of the Business Roundtable, which has having Social Security privatized as one of its policy aims. S&P was completely silent when the deficit widening Bush tax cut extensions were approved at the end of last year. Jane Hamsher has chronicled in detail how S&P swung into action on the deficit attack front when efforts to increase regulation of its activities ratcheted up. So having chosen to wage a political war, S&P should not be surprised to encounter this sort of pushback.

Ironically, the downgrade may provide the impetus to finish a Dodd Frank task that was left incomplete: that of reducing the importance of ratings in the investment process. As the Times story notes:

A successful case or settlement against a giant like S.& P. could accelerate the shift away from the traditional ratings system. The financial reform overhaul known as Dodd-Frank sought to decrease the emphasis on ratings in the way banks and mutual funds invest their assets. But bank regulators have been slow to spell out how that would work. A government case that showed problems beyond ineptitude might spur greater reforms, financial historians said.

“I think it would have a major impact if there was a successful fraud case that would suggest there would be momentum for legislation that would force them to change their business model,” said Richard Sylla, a professor at New York University’s Stern School of Business who has studied the history of ratings firms.

In particular, Professor Sylla said that the ratings agencies could be forced to stop making their money off the entities they rate and instead charge investors who use the ratings. The current business model, critics say, is riddled with conflicts of interest, since ratings agencies might make their grades more positive to please their customers.

Professor Sylla must be aware of the fact that investors were the ones who once paid to find out the rating of various securities. What led the ratings agencies to abandon this model? The Xerox machine. It made it easy for investors to pass on rating agency reports cheaply, depriving them of revenue. Now there are investment newsletters that face the same problem, and go to some length to protect their intellectual property, but they are also much smaller businesses than the ratings agencies. In addition, with ratings still enshrined in various regulations and investment guidelines, it is the part that is valued most – the rating itself, rather the commentary – is also the easiest to disseminate.

A friend who is fond of intrigue has said, ‘If you challenge the king, you must kill him.” S&P may learn the consequences of failing to heed his advice.

Update: 1;30 AM: Reader MBS Guy pointed out that it would have been trivial to make this probe look more even-handed, since Moody’s has engaged in similar conduct:

On the other hand, the SEC already has plenty of ammunition for a similar investigation of Moody’s. In the SEC’s request for comments on the proposed new rules for rating agencies (NRSROs), a disgruntled former Moody’s employee submitted a long, detailed account of how senior management at Moody’s improperly influenced the ratings process, intimidated and harassed employees and promoted for MBS and CDO managing directors because to fire them would be an admission of guilt. Not only that, senior management at Moody’s, which was largely intact even after their obvious failures before the crisis, continued to cover up their failures and harass employees as recently as last year (and probably beyond).

The report can be found here.
It’s a little disjointed and long winded, but it is a pretty devastating report on how bad the rating practices and management were at Moody’s and, by implication, how little was done about it.

I had thought it was pretty weird to hear the SEC claim, as they do in the article, that it was having trouble finding ex S&P employees who were willing to testify against the ratings agency. MBS Guy agreed:

This is pretty silly. I know of a dozen former employees of Moody’s and S&P who have openly complained about these issues and a number of them have already spoken to various regulators. In fact, if the SEC wanted ammunition for these types of claims, they need only go to their own website, where a former Moody’s employee named William Harrington has posted a long report on Moody’s in response to the SEC’s request for comments on the proposed regulations for NRSROs.

So much for the SEC’s ability to do research….

Print Friendly, PDF & Email


  1. Hugh

    the SEC is looking into whether it has grounds to file suit against the ratings agency Standard & Poor’s for publishing higher ratings on bonds than the analysts had recommended

    Wake me when something actually happens. One corrupt entity maybe filing suit against another corrupt entity doesn’t sound like much to me. The SEC failed to go after the ratings agencies for their crucial role in the biggest and most expensive frauds and lootings in history. Somehow I think there is much less here than meets the eye. At most it is some clumsy payback for the downgrade but from a player with as little credibility as the SEC this looks mostly like kabuki.

    1. Tao Jonesing

      We need to remember that the Pecora Commission did not begin in earnest until almost three years after the Crash of 1929.


      Unfortunately, we need to also remember that many of the same mechanisms of fraud employed in the run up to the Great Depression were highlighted by the Pujo Committee (which took 5 years to look into the Panic of 1907), which ultimately led to the creation of the Federal Reserve system (you know, that monopoly that oversees our private debt-money system?).


      If you spend any amount of time reviewing the fraudulent practices employed back in the day, it is easy to see that things like HFT, dark pools and derivatives are just new versions of the old frauds . . .

      Brick by brick, the foundation of trust upon which the fraud rests is being eroded. It may take more years to completely crumble, but crumble it will.

      By that time, though, MMT will have been co-opted as the new orthodoxy by the same people who perpetuated the last fraud through modern finance theory overlaid upon neoliberal economic doctrine.

      The fraudsters did it to Keynes, they’ll do it to MMT. And MMTers will be completely ignorant of the fact . . .

      1. Jeff65


        I agree with everything you’ve said here with the exception of the characterisation of the money system as private. I wonder if that difference really matters. I’d certainly agree that the way it’s been done is so as to benefit private interests.

        I posted an almost identical comment at Russ’s blog regarding MMT and Keynes before I saw your comment here.

  2. Patrick

    How long have they known about this? This investigation, whilst welcome, does smell of payback.

    But hey, I’ll take payback over inaction any day. Only action is known, intent is unknowable.

    1. Skippy

      Upgraded too Crazed Centaur coming off crack, who knows were it may strike…ummm.

      Skippy…watch out for that rakia, you actually see Centaurs.

  3. Conscience of a Conservative

    Do we really want for-profit companies like S&P actively engaged in government policy discussions like Social Security and Tax cuts. This is better handled by non-profit think tanks and the CBO. That the rating agencies made huge profits over at best incorrect and at worst improper ratings of MBS & CDO’S is all one needs to know here.

    The rating agencies are quasi-regulators that earn huge profits and have virtually no liability. It’s pathetic that they were never held to the Arthur Anderson standard of conduct. How can you rate the risk of an MBS if you don’t even audit the loan files. There’s no subordination level for fraudulent debt.

    1. Sufferin' Succotash

      “Do we really want for-profit companies like S&P actively engaged in government policy discussions like Social Security and Tax cuts.”

      It’s only been going on for the past century and a half. Not all innovations turn out to be helpful.

      1. Conscience of a Conservative

        Of course this is all in response to government policy trying to promote investment in one asset over another. Why a AAA mortgage is “safer” or a more desirable asset than something not a mortgage and unrated is part of the problem. The biggest blow-ups always seem to occur with assets the government deems “safe”. The only assets that are credit safe inside a sovereign country are sovereign debts of that country, nothing else.

    1. ambrit

      As in “Path(ocracy)s of Glory?” Or perhaps the “Hidden Hand (of Glory) of the Market?” Either way, it’s still Voodoo Economics.

  4. Pearl

    Below is a link to a pdf for an “Examination Report For Moody’s Investor Services, Inc.” that was conducted in 2007. It is very interesting.

    “On August 31, 2007, the Staff in The Commission’s Office of Compliance Inspections and Examinations (“OCIE”) Division of Trading and Markets (“Trading Markets”)and Office of Economic Analysis (“OEA”)(collectively, “The Staff”) initiated an examination of Moody’s and two other credit ratings agencies. The focus of the examinations was Moody’s activity in rating subprime residential mortgage-backed securities (“RMBS”) and collateralized debt obligations (“CDOs”)linked to subprime RMBS…..”


    (Page 7 of this pdf, item number 6, is particularly entertaining. But the whole report is interesting.)

  5. Richard

    It is nice to see the pressure ratcheted up on the rating agencies. The way to “replace” the agencies is to remove their informational advantage. Everything that is disclosed to the agencies should be publicly disclosed instead.

    With full disclosure, there are many firms who will offer analytical services. This includes (for better or worse) Wall Street and the large investment management companies.

  6. sheenyglass

    “Professor Sylla must be aware of the fact that investors were the ones who once paid to find out the rating of various securities.”

    Sure, but he probably didn’t mention it because that topic has been written on extensively by his rival at Wharton, Professor Steven H. Charybdis.

  7. john newman

    By letting the central power centers that our financial firms have become in our politics “get away” with rampant criminality for years our “unitary executive” gains the discretionary power to file criminal charges against any of them whenever it chooses. It would be fun to watch Obama use Holder extort protection money in person from say Jamie Diamond: a sort of “No Exit” with the executive, the regulator and the banker loving and hating each other into eternity while the rest of us move on.

  8. EL Snarko

    Investment ratings should be impartial. It should be a function of the government or at least the Fed. If left private it MUST be under fed watchfulness And based on computer analysis. What is good for the hedgies is good for this as well…..

    Oh yes and the ratings guys need to have an enforcable fiduciary responsibility as well. AND BE SUABLE !

    No enforcement=no law.

  9. brian

    flashback to Casablanca
    I’m shocked to see their is gambling going on here
    Your winnings sir
    Thank you

  10. DanJS

    >On the other hand, the SEC already has plenty of ammunition for a similar investigation of Moody’s. <

    In light of the allegations revealed by the Whistleblower at the SEC … that for "two decades" the SEC has been destroying investigative records, what is the "ammunition" assembled by the SEC?

  11. Hugh

    Thanks, Pearl. What Pearl cites bears reproducing here and wider distribution:

    The Staff notes that pursuant to its policies, procedure, and public announcements, Moody’s did not engage in any due diligence or otherwise seek to verify the accuracy and quality of the loan data underlying the RMBS pools it rated during the review period. In fact, the Code of Ethics for Moody’s clearly states the Moody’s is under no obligation to perform, and does not perform, due diligence. Moreover, it states that the assignment of a rating is not a guarantee of the accuracy, completeness, or timeliness of the information relied on in connection with the rating. Moody’s solely performed loss and cash flow analyses on the data presented to it. Moody’s generally did not verify the integrity and accuracy of such information as, in Moody’s view, due diligence duties belonged to the other parties in the process. Moody’s also did not seek representations from sponsors that due diligence was performed.


    I find it especially telling that Moody’s did not even, at a minimum, seek a representation from its clients that the information they were providing was accurate. This is the very definition of a Garbage In Garbage Out process. Their ratings were meaningless, but more than this, they were designed to be meaningless.

    There is a fundamental contradiction, or really admission, that lies at the heart of the Moody’s statement. Moody’s is saying that it does not measure real world risk but that is what its ratings are supposed to measure. You see abstract risk is precisely that, abstract. It does not impinge on the real world. In terms of the real world, it is always zero. It is like assessing the increased risk of air collisions if pigs could fly. In terms of the model, there is a finite, definable risk. In terms of the real world, the increased risk is zero. Pigs can’t fly.

    The same is true here. If there is no stated link to the real world, that is that the data presented to Moody’s represents reasonably accurate information about real loans, all Moody’s is doing is a “If pigs could fly” analysis. Because Moody’s is assessing an abstract risk, the value of that risk, in the real world, is always zero.

    And there you have it, ratings agencies that don’t assess real risk, but sell their services and are used as if they do. What does an AAA rating mean if it has no reference to real world risk? What does any rating mean? Nothing. I am sure the ratings agencies, because I am sure they all engaged in this sleight of hand thought they were very clever. But what is this other than a clear and open admission of fraud? How is it any different from the snake oil salesman who says his tonic of gin and turpentine will heal whatever ails you and then expresses surprise that anyone would take him at his word?

Comments are closed.