Is Standard & Poor’s Returning To Pre-Crisis Ratings Practices?

Amid a lawsuit over its role in the financial crisis, Standard & Poor’s (S&P;) is once again providing more favorable ratings for mortgage-backed securities than other ratings agencies, according to the New York Times. The company tripled its share of the bond-rating market in the first half of the year after banks looking to get back into the mortgage market discovered it was more willing than Fitch or Moody’s to call real estate securities a safe investment.

Firms dealing in mortgage-backed bonds walked away from S&P; when it toughened its ratings standards in the wake of the financial crisis, and the company went from rating 80 percent of bonds issued in 2006 down to just 22 percent in 2011. “People weren’t happy with losing market share,” one of the accountants S&P; brought in to tighten up its ratings practices told the Times, and in 2012 the company relaxed its standards again. In the next five bond deals it was asked to rate after that change, S&P; “offered higher grades than its competitors.” Fitch has provided higher ratings than S&P; just 8 percent of the time in the past year, and “on half of the deals that it rated since last September, S&P; has given at least a portion of the deal a higher rating” than competitors, according to the Times analysis.

This relaxing of standards in pursuit of profit is reminiscent of the failings of the ratings industry as a whole prior to the financial crisis. As subprime mortgages flooded the marketplace in the early and mid-2000s, ratings firms consistently overstated the safety of those loans and related financial products. They did so despite being warned the underlying loans were often doomed. By giving their stamp of approval to such products, they helped savvy Wall Street firms sell those doomed assets to other investors. In its final report, the Financial Crisis Inquiry Commission called the ratings agencies “essential cogs in the wheel of financial destruction.”

The Justice Department sued S&P; in February over its pre-crisis ratings practices, alleging the company had committed fraud and seeking a $5 billion penalty. The suit centers on the company’s declarations that its ratings are independent and objective, and S&P;’s lawyers tried to have the suit thrown out by arguing that nobody really believes those declarations in the first place. It didn’t work, and the suit will proceed. S&P; disputes both the government’s claims and the Times’ findings.