The New York Times reports today that the Justice Department had an investigation underway of the mortgage-bond ratings of Standard & Poor's before the service downgraded the U.S. government's debt on Aug. 5. If so, the followup should be: What's taking so long? And more to the point: Did Justice dust off a dormant investigation in retaliation for the downgrade?
These are serious questions, and one hopes the nation's top law enforcement agency would never stoop so low. But the suspicion arises because, three years ago, Bloomberg News articles quoted former high-level S&P employees -- some of them even allowed their names to be used -- saying the service, in order to reap fatter fees, placed a "for sale" sign on its reputation by slapping top grades on real-estate securities that violated S&P policy.
S&P and rival Moody's Investors Service were the two biggest companies rating pools of mortgages -- $3.2 trillion worth -- made to homebuyers with bad credit or undocumented incomes between 2002 and 2007. Those loans were packaged into securities, which the ratings companies graded as AAA and Wall Street firms sold to investors worldwide. The bonds were often assigned higher ratings than any of the underlying assets alone could get. The securities ultimately turned to junk when the borrowers started to default, bringing the global financial system to its knees.
The Bloomberg articles pointed out how S&P, part of McGraw-Hill Cos., and Moody's had substituted the judgment of credit analysts for dubious mathematical models, causing internal clashes that resulted in resignations and firings of analysts who tried to argue that the new criteria lacked integrity. One of the Bloomberg articles, published Sept. 25, 2008, quotes former S&P Managing Director Richard Gugliada saying that "…when the subject came up of tightening S&P's criteria, the co-director of CDO ratings, David Tesher, said: 'Don't kill the golden goose.'"
Today's NYT article says: "Investigators have been asking about a remark supposedly made by David Tesher about mortgage security ratings, two people said. The investigators have asked witnesses if they heard Mr. Tesher say: “Don’t kill the golden goose,” in reference to mortgage securities. The NYT piece also says Gugliada has been mentioned by Justice investigators.
Since the appearance of the Bloomberg articles, which were virtual roadmaps for investigators, Congress has held numerous hearings and adopted the Dodd-Frank financial reform law. That measure demotes the role of the credit raters and directs the Securities & Exchange Commission to regulate them more tightly. The SEC also has conducted its own inquiries.
The ratings companies may have performed abominably and deserved to be downgraded themselves, but it begs credulity that Justice would still be probing the "golden goose" remark three years hence. Or is it possible that Justice revived an existing, but long dormant, probe in April, when S&P first warned that it might downgrade U.S. Treasuries?
(Paula Dwyer is a member of the Bloomberg View editorial board.)