Editor’s Viewpoint: The standards should not be this poor

Interlaced with corruption and greed, the government's case against the venerable Standard & Poor's reads like a good novel. But the accused rating agency disputes the Justice Department's juicy tell-all, stating the government's evidence lacks context. The decision hangs on whether or not S&P knowingly misrepresented the credit worthiness of billions of dollars worth of securities backed by home mortgages.

Certainly, if S&P wasn't shocked by the Justice Department's recently launched lawsuit, it probably was surprised that the government is asking for $5 billion in damages — more than five times what it made in 2011 — which would be used to cover losses from investors, like state pension funds.

Specifically, S&P is being charged with knowingly rating about 40 securities higher than they deserved, magically transforming sub-prime mortgages into top rated mortgages. Blessed with highly rated securities, banks sold them to investors in 2007, at a time when the housing market was beginning to show signs of the problems to come. The government says S&P gave the securities high ratings to keep customers happy and win the business.

Proving that S&P knew the high ratings were unjustified is the hat trick whose success appears to rest on thousands of the company's internal documents, including emails from employees. For example, internal memos from as early as 2004 show certain executives wanted to change its ratings methodology, but only after they asked a number of issuers and investment bankers about the implications to the changes. Other S&P execs and analysts wrote memos saying that by asking its customers about changing the rating's methodology, S&P was implying that customers could influence them.

If the government wins, it will likely target S&P's competitors, Fitch and Moody's, with similar lawsuits and give credence to the suits brought by attorneys general in 16 states. Even if it fails to prove its case, the federal action alone should cause all three rating agencies to more carefully weigh the pressure to win business against the possibility of tarnishing the brand and bankrupting the business.

In either case, the nation's credit agencies' role in the financial collapse is significant, and their relationship with customers can prove dangerous. In this case, banks hired S&P to rate securities the banks packaged backed by mortgages. In the early part of the century, billions of dollars worth of those types of securities were being sold to investors who wanted to piggyback on money being made in the red-hot home mortgage market. But when the bubble burst, the value of those securities — then in the trillions of dollars — evaporated.

In the end, the ratings agencies are another key player in a system that led to the worst financial crisis in our lifetime. Guilty of either legal wrongdoings or just incompetence, watching their chapter unfold in this all-too-real story will be painful to its conclusion.

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