“The Obama administration’s suit against the rating agency Standard &Poor’s makes for riveting headlines and lousy history. We want to blame the financial crisis and Great Recession on greed and dishonesty. The charge that S&P rigged bond ratings for its own gain — providing artificially high ratings on the mortgage-backed securities that inflated the credit bubble — fits this self-serving morality tale. The discomforting reality is that the financial collapse resulted from an extended period of prosperity, which led to weakened credit standards and inspired wishful thinking about the permanence of economic growth.

“The administration is asking “in excess of $5 billion” in penalties from S&P, an amount it says reflects the losses caused by the erroneous ratings. Law professor Jeffrey Manns of George Washington University notes that the top three ratings agencies (S&P, Moody’s and Fitch) provide 96 percent of all ratings. A $5 billion penalty might put S&P’s parent company, McGraw-Hill, into bankruptcy and force S&P to close. A swarm of state lawsuits compounds the possibility. With many bonds rated by two agencies, Manns wonders whether it would be good public policy to convert the existing oligopoly into an effective monopoly.

The stakes here are enormous. After reviewing 20,000 pages of documents and e-mails from S&P, the Justice Department says that S&P hyped ratings of residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) to generate business. Banks and investment banks selling the securities pay for the ratings; higher ratings would attract more buyers. So S&P delayed introducing new risk models that would have lowered ratings, says Justice. S&P’s advice was not “independent” as claimed but was tainted by the pursuit of profits. Each CDO rating fetched fees from $500,000 to $750,000.”

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