The US Department of Justice is investigating whether the nation’s largest credit ratings agency, Standard & Poor’s (S&P), improperly rated dozens of mortgage securities in the years leading up to the financial crisis, two people interviewed by the government and another briefed on such interviews said.
The investigation began before S&P cut the US’ “AAA” credit rating this month, but it is likely to add fuel to the political firestorm that has surrounded that action. Lawmakers and some administration officials have since questioned the agency’s secretive process, its credibility and the competence of its analysts, claiming an error in its debt calculations.
In the mortgage inquiry, the Department of Justice has been asking about instances in which the company’s analysts wanted to award lower ratings on mortgage bonds, but may have been overruled by S&P executives, the people with knowledge of the interviews said.
If the government finds enough evidence to support such a case, which is likely to be a civil case, it could undercut S&P’s longstanding claim that its analysts act independently from business concerns.
It is unclear if the Department of Justice investigation involves the other two ratings agencies, Moody’s and Fitch, or only S&P.
During the boom years, S&P and other ratings agencies reaped record profits as they bestowed their highest ratings on bundles of troubled mortgage loans, which made the mortgages appear less risky and thus more valuable. They failed to anticipate the deterioration that would come in the housing market and devastate the financial system.
Since the crisis, the agencies’ business practices and models have been criticized from many corners, including in congressional hearings and reports that have raised questions about whether independent analysis was corrupted by the drive for profits.
The US Securities and Exchange Commission (SEC) has been investigating possible wrongdoing at S&P, a person interviewed for that matter said, and may be looking at the other two major agencies, Moody’s and Fitch Ratings.
Ed Sweeney, a spokesman for S&P, said in an e-mail: “S&P has received several requests from different government agencies over the last few years. We continue to cooperate with these requests. We do not prevent such agencies from speaking with current or former employees.”
The people with knowledge of the investigation said it had picked up steam early this summer, well before the debt rating issue reached a crescendo in Washington. Now members of the US Congress are investigating why S&P removed the nation’s “AAA” rating, which is highly important to financial markets.
Representatives of the Department of Justice and the SEC declined to comment, as are those departments’ customs, on whether they are investigating the ratings agencies.
A successful case or settlement against a giant like S&P could accelerate the shift away from the traditional ratings system. The financial reform overhaul known as Dodd-Frank sought to lessen the emphasis on ratings in the way banks and mutual funds invest their assets. However, bank regulators have been slow to spell out how that would work. A government case that showed problems beyond ineptitude might spur greater reforms, financial historians said.
“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,” said Richard Sylla, a professor at New York University’s Stern School of Business who has studied the history of ratings firms.