The Justice Department sued Standard & Poor’s Ratings Services late Monday, alleging the firm ignored its own standards to rate mortgage bonds that imploded in the financial crisis and cost investors billions. The government was seeking penalties of more than $1 billion…which would be the biggest sanction imposed on a firm related for its actions in the crisis.
This is market manipulation at its dirtiest. I’ll explain.
During the housing bubble, the government’s mortgage finance agencies, FNMA (Fannie Mae) and FHLMC (Freddie Mac), securitized scads of mortgages. That means they re-packaged them as securities – in this case, as bonds – which could be traded on Wall Street. And that helped the bubble along, because it made a lot more money available for people’s mortgages, especially sub-prime mortgages.
All three of the major U.S. bond ratings agencies – S&P, Moody’s and Fitch – gave the ‘securitized mortgage’ bonds the safest rating, AAA, which helped keep the housing bubble going. And that was what almost everyone wanted at the time, including the government.
Later, when the housing bubble burst, it was clear that these bonds did not deserve an AAA rating, and probably never had. The ratings agencies had been wrong, along with everyone else.
One question to ask is: why is S&P the first ratings agency, and so far the only one, to be punished after all this time? What distinguishes S&P? The answer seems fairly obvious: In August 2011, S&P downgraded the U.S. government’s own bonds, which remains a huge blow to Obama’s reputation.
Reports indicate that the government may also sue Moody’s. But they haven’t yet; any efforts there “are in the early stages, largely because state and federal authorities have dedicated more resources to the S&P lawsuit.” Golly, ya think?
So far, then, the moral of the story is: Don’t criticize Obama. Nice business you got there; would be a shame if anything happened to it.
But there is a deeper story: how market manipulation by the government causes bad outcomes; for which politicians (and other supporters of Big Government) always blame the market’s players, rather than themselves.
It was government which created Fannie and Freddie and had them massively support the sub-prime mortgage market. (For which GayPatriot has criticized Barney Frank’s involvement; see here, here, here, here, here, here, here and here.)
Moreover, as Peter Schiff reminds us, it was government which established the Big 3 ratings agencies in positions free from ‘consumer’ pressure, where they would descend into a culture of complacent groupthink that favored, not the small investor, but the big players:
In 1973, in order to “protect” investors from unregulated markets, the SEC designated certain ratings firms as “Nationally Recognized Statistical Ratings Organizations.” Thereafter, only bonds rated by sanctioned firms could be purchased by pension funds and federally insured banks. Before that time the ratings agencies were paid for their advice by bond investors. As the rule change limited the abilities of investors to choose who to ask, the ratings firms began charging bond issuers instead. This arrangement meant that interests of investors would be subordinated.
…to the interests of the bond issuers. In short, in 1973 the government gave the watchdogs secure, protected positions. Over time, they were no longer paid to remain good watchdogs. Due largely to government action, they evolved into salesmen for the wolves (including the government). And then we had a housing bubble.
The crimes continue. For the past few years, we have been in a new financial bubble centered on U.S. Treasury bonds. The Obama administration, needless to say, can’t afford to let that bubble burst. So, it wants the bond agencies to give U.S. Treasury bonds the highest possible rating, denying that anything is wrong with the U.S. government’s finances. As Schiff says:
Smaller ratings agency Egan Jones (which never had the [government’s protection]) issued harsher reports about government debt, and they have also been duly punished for their candor.
And that’s the real message of the government’s selective punishment of S&P: Play ball. Do not downgrade U.S. debt, no matter how much reason we give you to. As Schiff observes:
In 2011 the other major ratings agency, Moody’s, argued that the fiscal cliff deal agreed to by Congress and the President improved the country’s fiscal position and forestalled any need to downgrade Treasury debt. However, since we never actually went over that conveniently erected fiscal cliff, why has Moody’s not responded with a downgrade [now]? Perhaps they want to stay out of court?
I believe that all the ratings agencies have reason to (further) downgrade U.S. bonds. But I will be surprised, if any of them do it soon.