Federal and state prosecutors sued the credit rating agency Standard & Poor's this week for allegedly defrauding investors by giving inflated ratings to complex mortgage-backed securities that proved all but worthless after the housing bubble burst. The cases raise difficult questions about the freedom to express an opinion without being held liable if it's wrong. Nevertheless, it's worth exploring whether S&P and its rivals deliberately soft-pedaled how risky those securities were in order to boost their bottom lines.
There's plenty of blame to go around for the subprime mortgage meltdown and the subsequent Wall Street collapse, starting with the mortgage brokers and lenders who didn't care about borrowers' ability to repay. But the rating agencies played a particularly important role in pumping up the housing bubble. By giving their top rating to many securities backed by home mortgages, including subprime loans, they enabled more of these investments to be sold. They also encouraged federally insured banks, public pension funds and other taxpayer-backed institutions to sink money into what would become a financial black hole.
On Tuesday, the Justice Department and California Atty. Gen. Kamala Harris announced that they had filed suit against S&P for violating a federal bank fraud law and a state false claims statute. Both alleged that the agency promised independent, objective evaluations but that it in fact used a rating system it knew to be flawed — and which helped S&P's customers sell securities and generated more business for S&P. The agency denied the allegations and argued that it simply expressed an opinion that investors were free to disregard.