Feds probing S&P over mortgage ratings: report

The Justice Department is probing whether Standard & Poor's improperly slapped high ratings on mortgage securities during the run-up to the 2008 financial crisis, sources say. Credit raters were widely accused of abetting the housing bubble of the early aughts, and the Justice investigation could have a major impact on how they operate.

The Feds are looking into possible instances where analysts at S&P and other rating shops were pressured into revising lower ratings upward, reports the New York Times, citing "two people interviewed by the government and another briefed on such interviews."

S&P, a unit of the McGraw-Hill Companies, told the Times it's co-operating with the investigation.

S&P endured a barrage of criticism from the Obama administration and others earlier this month when it downgraded the U.S. credit rating, citing concerns over the deficit and political dysfunction. But the Justice Department's probe, which is likely to spark a civil rather than a criminal case, is said to have started well before that move.

Several breakdowns of the 2008 financial crisis affixed blame to the major ratings agencies such as S&P, Moody's and Fitch for continuing to award high ratings to some mortgage securities--and raking in record profits--even after widespread problems in the underlying mortgages were well known.

It's not clear whether the Justice investigation is also focusing on Moody's and Fitch. "We are not aware of any government investigations involving Fitch Ratings," Sandro Scenga, a spokesman for the firm, told The Lookout via email. Moody's did not immediately respond to a request for comment.

The Times reports that investigators have asked witnesses whether they heard S&P's David Tesher say: "Don't kill the golden goose," in reference to mortgage securities.

Giving generous ratings to such securities was lucrative for S&P, because the agencies are paid by the banks whose securities they rate, leading many to argue they have an incentive to offer high ratings, in order to hold on to their clients. Indeed, banks frequently shop around from one agency to another, in search of a good rating. (The U.S. government is an exception: It does not ask for a rating, and does not pay for one.)

That system of perverse incentives is still in effect. But if the Justice Department were to bring charges against S&P, that could create change in a hurry. "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," Richard Sylla, a professor at New York University's Stern School of Business, and an expert on the ratings agencies, told the paper.

A provision of the Dodd-Frank financial reform law of 2010 made the agencies legally liable for their ratings. S&P has been lobbying lately to undo that provision.