The Defense Mounted by S&P Is As Jaded As Its Ratings of Subprime Debt

By Pam Martens: September 4, 2013 

Someone needs to instant message Standard and Poor’s Financial Services LLC a legal tip: when you’re in a hole, stop digging. That would be potentially more sage advice than it’s currently getting from the three law firms representing it in its court battle with the U.S. Justice Department over the alleged bogus ratings it assigned to subprime Residential Mortgage-Backed Securities (RMBS) and Collateralized Debt Obligations (CDOs) in the run up to the Wall Street financial collapse in 2008. 

In a court filing yesterday, S&P attempted to cast aspersions on the motives of the government in bringing the suit, telling the court: 

“Plaintiff commenced this action in retaliation for Defendants’ exercise of their free speech rights with respect to the creditworthiness of the United States of America. Such free speech is protected under the First Amendment to the United States Constitution and the retaliation, causing and embodied in the commencement of this impermissibly selective, punitive and meritless litigation, is unconstitutional. Only S&P Ratings downgraded the United States and only S&P Ratings has been sued by the United States…” 

The reality is, only S&P built the government’s case with internal memos, emails, instant messaging and even a song and dance number showing gross disregard for the welfare of the financial system of the United States, investors and homeowners, as it plotted how to “massage” its ratings to grab revenues and market share from its competitors. The ratings agencies, including S&P, are paid huge fees to rate investments by the very Wall Street firms that will benefit from an attractive rating, such as AAA. 

In some kind of pathetic gesture of adding credibility to its free speech argument, S&P has hired Floyd Abrams, the constitutional law expert, as one of its attorneys. 

The U.S. government filed its complaint against S&P, a division of the publishing powerhouse, McGraw-Hill Companies, Inc., on February 4 of this year. The complaint reveals, for the first time, just how much early warning S&P had to the epic housing collapse that was to overtake the U.S. economy a few years later. According to the government, its overriding priority of increasing revenues and market share drove its decision to stall in making its findings public in the form of credit downgrades. 

The Justice Department, in its complaint, has actually pinpointed the date that S&P went to hell in a hand basket. On April 20, 2004, a meeting was held among S&P executives to discuss a new process for ratings. According to the complaint, “Circulated at the meeting was a draft document setting out the new process, which required consideration of ‘market insight,’ and ‘rating implications,’ and the polling of both ‘3 to 5 investors in the product ,’ and ‘an appropriate number of issuers and investment bankers for a full 360 market perspective.’ ” 

One employee of the company was so incensed by the implications of this meeting that he dashed off an email to his superiors, asking: “What does ‘rating implication’ have to do with the search for truth. Are you implying that we might actually reject or stifle ‘superior analytics’ for market considerations?” The employee never received a response to his email. 

On March 23, 2005, an analyst wrote to his colleagues about a stalled upgrade to a key S&P ratings evaluation tool, stating: “Version 6.0 could’ve been released months ago and resources assigned elsewhere if we didn’t have to massage the sub-prime and Alt-A numbers to preserve market share.” 

In the Fall of 2006, effectively one year ahead of when the general public learned about the deteriorating quality of subprime loans, S&P already knew of massive problems. On November 14, 2006, an S&P executive sent an email to his colleagues, stating: “…I have attached a report that shows that more than 50% of the sub prime deals rated in 2006 have severely delinquent loans that represent 25% or more of credit enhancement for the lowest rated [class]. Many have realized loses already.” 

According to the Justice Department’s complaint, this same employee, from the Fall of 2006 to the Spring of 2007, regularly complained to her coworkers that despite this dire performance, her bosses prevented her from downgrading the ratings “because of concern that S&P’s rating business would be affected if there were severe downgrades.” 

Showing inside knowledge of just how bad the situation was, on December 11, 2006, an S&P executive wrote: “On a separate issue, this market is a wildly spinning top, which is going to end badly.” Not, “could end badly,” or “might end badly” or “has the potential to end badly,” but a boldly declarative statement that it “is going to end badly.” 

On March 1, 2007, this same executive held a meeting with S&P analysts, informing them that: “issuers were shutting down and liquidating their warehouses [of subprime loans held for securitization] in part to enable the issuers to avoid being required to mark their positions to market…and being stuck with collateral that had suffered losses.” In an instant message following this meeting, one analyst wrote: “that means market will crash…deals will rush in before they take further loss.” 

On March 21, 2007, an analyst at S&P circulated an email which contained an attached video. In the video, the analyst is singing and dancing to his remake of the song, “Burning Down the House” by Talking Heads. The last stanza of his little ditty went like this: “Own it; hey you need a downgrade now; Free-mont; Huge delinquencies hit it now; Two-thousand-and-six-vintage; Bringing down the house.” 

There is only one aspect that is more demoralizing than reading the internal memos and emails contained in the U.S. Justice Department’s complaint; knowing that despite the Dodd-Frank financial reform legislation, S&P is still being paid for its ratings by the issuers on Wall Street while the hangover from the financial collapse has left 46 million Americans living in poverty, including two out of every five children, and the greatest wealth inequality in the last century.

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