The role of a ratings agency is to make an honest assessment of the value of debt vehicles (e.g. bonds) such that investors can make an informed decision about the wisdom of backing it. The ratings agencies get a commission from the bond issuer for providing this service – inevitably, this opens the door to suspicion of the ratings agencies having a vested interest in the success of such issues.
The genesis of the global financial crisis was a loss of confidence which was triggered by the sub-prime mortgage debacle. Sub-prime mortgages were bundled together and sold to investors as AAA (top) investment grade security – the idea that any individual defaulting mortgage would be weighted out by the rest of the package which made it to maturity. This has all the wisdom of setting out on a sea voyage with a flotilla of leaky boats and praying that you don’t encounter a storm. It is always easy to be wise after the event, but many analysts have characterised these investments as “highly risky” which is the antithesis of investment grade securities.
The US government intends to launch a civil law suit against leading ratings agency Standard and Poor’s which will focus on the rating given to these investments (also known as CDOs or Collateralised Debt Obligations). S&P will argue that the case is devoid of merit and that the ratings which it provides are protected under the First Amendment of the US Constitution as opinions.
In a statement released on Monday, the ratings agency said: “every CDO that has cited to us also independently received the same rating from another rating agency. The Department of Justice would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith”.
S&P “deeply regrets” that CDO ratings did not anticipate conditions in the mortgage market when the financial crisis hit. It notes that it has spent $400 million to improve the quality of its ratings since the crisis struck – which does seem perilously close to an admission of failure.
News of the lawsuit sent S&P’s parent company stock (McGraw Hill) down by 14% and rival ratings agency Moody’s’ stock took a 10% hit. It is likely that some States will join the government lawsuit.