Sunday, February 10, 2013

Why the DOJ's Lawsuit Against S&P Will Do More Harm Than Good

On the heels of Monday’s announcement by the Justice Department that civil fraud charges have been filed against Standard & Poor’s and McGraw-Hill Financial Inc (MHFI) for accusations of intentionally misrepresenting the credit ratings of mortgage securities and the banks that issued them during the three years before the housing bubble burst, the DOJ is also reportedly considering an identical suit against Moody’s Corporation (MCO).

The lawsuit against S&P is unprecedented, as there has never before been a suit of this type against a ratings provider. Perhaps that’s also one of the reasons that so many state prosecutors are jumping in on the suit, not to mention the possibility of separate actions from the SEC.

News of the lawsuit hit hard, dragging shares of McGraw-Hill down over 25% and Moody’s over 15% this week. It’s likely that investor confidence will remain low, and these stocks might experience even greater declines as the lawsuit progresses and details of the apparent connivance hit mainstream media.

While corporate conspiracy is nothing new, the possible ramifications stemming from a guilty verdict in the case against S&P, or later against Moody’s, could create a tidal wave of similar lawsuits filed by countless banks, insurance companies, other financial institutions and even individual investors, all claiming that they lost money after trusting the ratings industry to publish proper evaluations.

Many consumers take it for granted that the ratings affixed by S&P and Moody’s are independent and unbiased. The relationship between the ratings industry and the organizations for which ratings are provided is rarely considered by most investors. The fact that S&P and Moody’s are for-profit companies, and they get paid for their ratings by the very companies who receive them, is a conflict of interest that’s essentially remained behind the scenes for average investors.

If the Justice Department’s case is proven, and it’s ultimately determined that S&P knowingly committed fraud by intentionally issuing favorable ratings to undeserving companies and securities, how plausible is it that these occurrences were not simply limited to the mortgage industry over a three year period?

Could S&P and Moody’s have been granting higher ratings to other companies in other industries over longer periods of time? To allow that possibility opens the door for investors to question the validity of every rating ever issued by these companies.

Picking the right investments is challenging enough without adding the variable of purposely inflated ratings. If S&P and Moody’s ratings are found to be fraudulent, how might the market react when investors are suddenly unsure about whether to trust the ratings industry? Our country’s economy has been battered enough, and it’s hard to see the DOJ’s lawsuit as anything but another crack in the foundation.

This article is a Twisted Nonsense Exclusive! (02/10/2013)

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