It’s been a really rough week for Standard & Poor’s. As we noted Wednesday, the Securities and Exchange Commission is “reviewing” the rating agencies’ recent decision to downgrade the federal government’s credit rating, which is totally inconsistent with actual economic indicators of the country’s ability to pay its debt. The Senate Banking Committee is “gathering information” into that decision as well.
Yesterday, the New York Times reported that the Department of Justice has been probing Standard & Poor’s for its role in blessing toxic mortgage-backed securities in the years leading to the financial crisis those instruments ultimately caused. The investigation could “accelerate the shift away from the traditional ratings system,” the Times notes.
The Justice probe focuses on whether managers at Standard & Poor’s deliberately kept high ratings for mortgage-backed securities, despite the advice of some of the company’s analysts, in order to preserve income from the very trading firms that trafficked in the dangerous tranches. According to the Times, investigators are questioning witnesses who might have heard Standard & Poor’s managing director David Tesher warned employees: “Don’t kill the golden goose.”
Senator Al Franken wrote an opinion piece for CNN today highlighting another bit of evidence: a 2006 e-mail from a Standard & Poor’s official, which said: “Let's hope we are all wealthy and retired by the time this house of cards falters.”
As experts are trying to piece together why Standard & Poor’s made a clearly political, and clearly not economic, decision to downgrade the federal debt, it’s crucially important to include the context of these ongoing investigations.
While nobody else knows what is driving Standard & Poor’s to act, it is easy to see how it might believe the downgrade helps them—first, because while under attack for being blind to the mortgage-backed securities, they can now appear tough-minded about a debt crisis, which while again isn’t economically present, is taken seriously by many DC policymakers.
Moreover, by issuing the downgrade and striking a blow against the administration, Standard & Poor’s may be hoping to paint any ongoing investigations as retribution. If that’s the strategy, it’s starting to work. The lead of an ABC News story on the Justice investigation, for example, asks if the downgrade has made Standard & Poor’s “a lightning rod for critics and regulators.” The Washington Post similarly characterizes the investigation as “likely to add to the political firestorm created by the downgrade.”
But the house of cards is faltering outside of Washington, too. Municipalities across the country are abandoning Standard & Poor’s after being downgraded themselves, often unfairly. Municipalities have been asking Standard & Poor's and other agencies to rate their finances since around 1994, essentially as a public relations move following a major financial crisis in Orange County, California.
In just the past week, the City of Los Angeles; Manatee County, Florida; and San Mateo County, California, have all dropped Standard & Poor’s after being downgraded. “We found the whole process of the downgrade flawed,” the treasurer of San Mateo County told the Wall Street Journal. The county will save $20,000 annually by not paying Standard & Poor's, and won't sign up with another rating agency in the near future.
Standard & Poor's downgraded those municipalities because they held US Treasury bonds, so it flowed from the original flawed federal downgrade. But some recent downgrades have been even more unfounded—for example, Standard & Poor’s issued a recent downgrade report on the county of Manassas Park, Virginia, citing in part increased salaries for public employees.
There are two small problems: Manassas Park is a city, not a county, and they haven’t increased salaries in two years. Local officials pointed this out, but the downgrade was not retracted. (City officials told the Wall Street Journal they are not dropping Standard & Poor’s, however).
In any case, it’s particularly galling for some local officials who saw their municipality downgraded by Standard & Poor’s, even if the assessment is technically fair. Local finances are often in trouble precisely because they are still holding toxic mortgage-backed securities that Standard & Poor’s dubbed safe earlier in the decade. For example, Manatee County is still holding about $1 million in toxic debt—something Standard & Poor’s cited in its recent decision to downgrade the county’s rating.