The very belated Federal civil suit against Standard & Poors is based on one very specific deal, with an extremely egregious email trail. Looking at the entirety of the crisis, the Credit Rating Agencies (the properly blamed CRA) were major players. Standard & Poor’s and Moody’s as well as the much smaller Fitch ratings agencies all appear to be culpable for similar frauds.

Here is what I accuse them of doing:

1. Business Model: They shifted their business model from an investor-pays-for-research to an underwriter-pays-for-ratings. Normally, any company is free to change their business model. But the major ratings are not just any business — these firms were all “Nationally Recognized Statistical Rating Organization” (NRSRO) — which the SEC allows other firms to rely on for regulatory purposes.

2. Ratings that were fraudulent: There is overwhelming proof that the ratings agencies knew what they were cranking out misrepresented the quality of the underlying bundles of paper. They did this because they were paid by the underwriters to generate an investment grade rating. THAT WAS THE SOLE PURPOSE OF THE RATING AGENCIES. Hence, why they were called the “great enablers of the credit crisis” by the likes of Joseph Stiglitz and the FCIC.

3. Ratings Based on Bad Assumptions: “Home prices never go down” is the silly excuse we have heard over and over again — except for the many, many examples that disprove this (Great Depression being the most prominent). That false assumption / limited data set allowed the rating agencys’ models to reach an investment grade, A rating. If they actually built in the possibility of lower home prices, and you cannot get the same ratings out of subprime mortgage securitizations. S&P may want to plead Stupidity, and I suspect the prosecution will defer — but stupidity does not present a shield to civil liability.

4. Ratings that were not rated: The sheer volume of mortages moving through ther system overwhelmed everyone. Reports of securitized bundles of mortgages — unreviewed, unscrutinized, unanalyzed — yet nonetheless still managed to receive a AAA rating.

There are more examples, but let me simplify this for you: In an ultra low rate environment, Fixed income managers were under tremendous pressure to find yield. Their  solution was to buy paper that was rated investment grade by the major credit ratings agencies EVEN THOUGH THEY KNEW OR SHOULD HAVE KNOWN IT WAS NOT. The agencies rated junk paper as AAA not because they believed it, but because they were paid to do so.

Had they not engaged in this sort of fraud, an enormous amount of securitizations of junk paper COULD NOT HAVE HAPPENED. There was no market for non-investment grade subprime paper.  That many less CMOs means that many less RMBS means that many less junk mortgages underwritten.

I do not want to excuse the bad purchase decisions made by the buyers of this junk — they clearly violated one of the first rules of investments: Know what you own. However, the complexity of these products required they use third party analysts and agencies to facilitate the purchase decision. That is why the bad pourchases is merely lousy investing but the payola-like ratings are actual fraud.

It started with the Greenspan Fed, but the next group in our Calvacade of Blame are the rating agencies.

If Arthur Anderson received the ultimate penalty for their part in the Enron and other fraud, I see no reason why Moody’s and S&P don’t suffer the same fate — plus criminal prosecution for senior management.

Its time to re-establish the rule of law in this country.

Category: Bailouts, Crony Capitalists, Legal, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

33 Responses to “Why the Ratings Agencies Deserve the Death Penalty”

  1. gordo365 says:

    AAA rating should be reserved for those organizations who can print money in a pinch.

  2. Moss says:

    I doubt that they will get an explicit death penalty sentence. That would mean that the legislators would have to admit to their mistakes. They may be able to save themselves by giving up the TBTF banksters.

  3. ConscienceofaConservative says:

    There should be no such thing as sanctioned ratings. In it’s place there should be companies selling /providing models with the end user responsible for the assumptions. Especially in the credit space, ratings make no sense. The assumptions drive the results as much if not more than the model itself.

    Also do not understand how one rates a deal without auditing the collateral

  4. bobnoxy says:

    Sure, S&P should be prosecuted, but why did it take this long, and why just them? I’m not defending them, of course, but it looks odd. There were many players at that corrupt table, and the rating agencies were but one of them. Nobody is even mentioning Congress and their role in this over the years.

    The idea that this is politically motivated after the Egan Jones case is bothersome. That we can’t live without the banks that were at the center of this massive con and rewarding them like we have is repulsive. That S&P will likely settle for a slap on the wrist penalty without anyone being truly held accountable is expected, and maybe the most troubling.

  5. stonedwino says:

    The TBTF banks much be shitting themselves…what happens to all the CDOs when S&P goes down? Does the whole house of cards go down and we actually have no choice but to break them up? Grab the porpcorn…

  6. gloeschi says:

    Absolutely, hands down, rating agencies have to accept a large part of the blame. Just for fairness: wasn’t it the banks that gave the rating agencies their models on how to evaluate default probabilities for CDO’s? Rating agencies had built up large databases on companies, things with real sales, products and customers, and were hence able to make accurate default predictions based on experience. Yes, the most important driver for defaults on mortgages is the house price, but what would you have put into the model at their place? “AAA, subject to house prices being at least flat?”

    How is saying a CDO is AAA different from Wall Street Brokerages saying Apple is a “buy” (and then stock price goes down)?

  7. DonF says:

    I simply cannot believe or understand why the DOJ have not gone after these agencies sooner. They seem to have the absolute easiest case to prove on knowingly committing fraud. And as long as Buffett has a stake in Moody’s, I believe the DOJ will never bring any charges against that firm.

    I’ve written to my Senators and Rep a few times on the ratings agencies. Every time I see them upgrade or downgrade anything, my blood pressure rises a little. How they remain in business is a travesty.

  8. A says:

    If the government loses this case, it will effectively tell all of the Wall Street executives that the two-tiered justice system does in fact exist and, that they can breathe easily and forget about the fraud they committed.

    If Obama truly wants to leave a legacy, he’d better move quickly in getting those white collar criminals incarcerated.

    Silly me.

    But it would make a good movie.

  9. Oral Hazard says:

    This is a civil suit being filed under FIRREA, a federal statute designed to protect FDIC-insured institutions. The government’s case is not that S&P sucks at life but that their fraudulent ratings led certain financial institutions to carry securities that, in reality, were below the AA- investment grade threshold these banks are limited to by banking regulations. Expect S&P to fight like hell to argue that FIRREA shouldn’t be applied here.

  10. beezle says:

    And the lenders had no power over the rating agencies? Lets start at the right place. Take legal action against the banks and brokers, shut their firms down and sell the assets off. Then feel free to go after the ratings agencies for whatever nefarious deeds one can prove. It would help too if we could jail the Fed and Treasury for their roles but we all know that ain’t happening.

  11. sparta47 says:

    Agree the rating agencies should be pursued. Why has it taken so long.

    How can there be enough evidence to pursue them & not the sellers of the securities that were improperly rated?

    How can the government have enough resources to pursue insider trading & not the precipators of the financial crisis?

    Why are the banks & their excutives “Untouchable” & Too Big To Jail”

    Why is the FDIC the indirect guarantor of banks derivative trading. They have notational value in the trillions at each TBTF bank!

  12. [...] Ritholtz headlines this post Why the Ratings Agencies Deserve the Death Penalty, and I was ready to agree!, only, unfortunately he doesn’t really fully stake out that [...]

  13. Oral Hazard says:

    I should have said MHP, since S&P is a wholly owned subsidiary and MHP is the real defendant here.

  14. Oral Hazard wins best comment of the day award !

  15. AnnaLee says:

    Maybe – Since the rating agencies continued to be allowed to determine the credit worthiness of the US, the State, and the Local governments, they have extortion rights. So low level prosecution, slap on the hand and everyone goes back to their corners.

  16. Watch the latest Frontline episode online, the don’t want to go after anyone because they are all too gig to jail.

  17. td says:

    I’ve read the DOJ complaint and I just don’t see the “overwhelming proof” that they knew they were perpetrating a fraud. Obviously they were desperately mistaken and Im not trying to defend them or their model necessarily but I also don’t know that we aren’t simply making a judgement with the enormous benefit of perfect hindsight, particularly if we’re talking about an Arthur Anderson like death penalty. The thing I always come back to is that someone was on the other side of these trades and people like Bass, Paulson, and others made an enormous amount of money shorting these things so the fact that the rating agencies were under reporting the real risk was a knowable thing….. one could discover that if they chose to open their eyes to it….. if they were knowingly committing a fraud wouldn’t more of the people involved have hedged what they knew to be their exposure to fraudulent securities by shorting them as we’ll?

    _____

    BR: I have researched this subject extensively — the evidence of fraud is overwhelming. I’ve detailed as much in these pages.

    But if a Big Picture reader does immediately know where the bodies are buried, well then I better go back to my notes and put together a summary for newbie readers.

  18. mad97123 says:

    They have the “When the herd runs, we have to run with them defense” similar to “When the music plays we have to dance” excuse. What is your fund manager doing now?

    S&P defense lawyer Floyd Abrams noted that the Federal Reserve, the Treasury Department and other government agencies all said there was little risks posed by mortgage-backed securities, and rival firms awarded similarly high ratings to some of the bonds rated by S&P.

    “We find ourselves now being accused of acting in bad faith, while everyone else acted in good faith, presumably,” Abrams told Bloomberg Television. “The fact is everyone tried and everyone failed to make good predictions about the future, and it is wrong for S&P to be accused in these circumstances.”

  19. DeDude says:

    Force them to offer CDS at a rate that is proportional to their rating. As a matter of fact get rid of those silly letters and just let the “rating” be the price of insurance against default. If they are forced to put their money where their mouth is then they will be a little more careful about what they are saying.

  20. ToNYC says:

    The ‘rated payer’ business model rather than independent and dispassionate model allows only the gaming of the supposed independent judges, but a far cry better than the SRO situation which is equivalent to the current self-ticketing by speeders and self-deportation genius solutions.

  21. Slash says:

    Those emails were “cherry picked.” You know, like when prosecutors try a guy for murder and cherry pick the murder evidence out of all the times the guy DIDN’T commit murder.

    I mean, c’mon. Just because an analyst says the stuff they’re rating is junk, essentially, and expresses hope that they (the analysts) are retired and rich before the shit hits the fan … you’re reading intent to mislead into that?

  22. 873450 says:

    “If Arthur Anderson received the ultimate penalty for their part in the Enron and other fraud, I see no reason why Moody’s and S&P don’t suffer the same fate — plus criminal prosecution for senior management.”

    In today’s upside down, alternative universe Arthur Anderson gets blamed, prosecuted and destroyed while Enron gets bailed out, rewarded and sheltered from liability.

    Elliot Ness flipped Al Capone’s accountant to nail Capone. Today he would kill the accountant so Capone can walk free committing more crimes.

    Let’s not get distracted by government targeting blameworthy, but peripheral, Big Lie culprits while it ignores the elephant in the room that keeps getting bigger.

    Who’s next? Appraisers?

  23. beaufou says:

    S&P’s defense:
    “there was no fraud because the ratings that were issued…were believed by the people who issued them and that’s what the government has got to disprove.”

  24. beaufou says:

    “Let’s not get distracted by government targeting blameworthy, but peripheral, Big Lie culprits while it ignores the elephant in the room that keeps getting bigger.”

    That’s all they can afford, prosecuting the elephant to bail him out later?

  25. jbegan says:

    The ratings agencies thankfully are not too big to fail, so they won’t be missed, and taking them all at their word when they testified at Congress, their ‘opinions’ are just that, so they obviously serve no purpose. Kill them off. They’re leeches on the system.

  26. singfoom says:

    They do deserve the death penalty, but until criminal cases are brought against individuals, it’s not that reasonable to expect a change in behavior or even for those at S&P to recognize that they enabled fraud.

  27. Bridget says:

    bobnoxy Says:

    “Sure, S&P should be prosecuted, but why did it take this long, and why just them? I’m not defending them, of course, but it looks odd. ”

    Payback for downgrading US debt?

  28. [...] With Cars and Girls offered up his own view of this concept, as he replied to a recent post from Barry Ritholtz.  Barry writes: “I do not want to excuse the bad purchase decisions made by the buyers of [...]

  29. KLeBrun says:

    Prosecuting anybody on Wall Street is a huge political risk which would likely have resulted in a massive cash infusion through Karl Rove to derail any re-election prospects.

    So, the likely reason for Obama to wait for the second term is that there is no longer a re-election risk.

  30. td says:

    BR: I have researched this subject extensively — the evidence of fraud is overwhelming. I’ve detailed as much in these pages.

    But if a Big Picture reader does immediately know where the bodies are buried, well then I better go back to my notes and put together a summary for newbie readers.

    ~~~~~
    Im am aware that you have written extensively on this subject and I appreciate your work and constancy on the subject and Im perfectly willing to accept any outcome that the facts bear out. Clearly the rating agencies knew they were in a bind with regards to their business model and clearly they had motive…. but at the end of the day the fact remains that when Paulson, Bass et al were shorting these securities they were shorting the same computational mistake that *every other player* in the market was making, the Fed included …… If we’re talking about shutting people down and chaining the doors forever then we need the bodies and as of yet we don’t have them.

  31. Robert M says:

    I am in total agreement about eh death penalty. This should be a fight between two T-Rex’s and everyone should get out the way because there will be a big stink for a long time afterwards. Two problems, one if past is prologue the govt will fold. The second is the people who received the mortgages that were fraudlent still receive no relief.

  32. [...] < What went wrong with finance? < Fault Lines… Get flash to fully experience Pearltrees Why the Ratings Agencies Deserve the Death Penalty The very belated Federal civil suit against Standard & Poors is based on one very specific [...]

  33. [...] S&P and Moody’s deserve the death penalty? Barry Ritholtz thinks so–here’s what the “Bailout Nation” author had to say: …Let me simplify this for you: In an ultra low rate environment, Fixed income managers were [...]