OPINION: Rating Agency Moody’s pays $864m to settle probe into inflated ratings

Moodys

By Pinky Khoabane

Moodys

Those of us who live in South Africa know fully well the extent to which our country is beholden to the rating agencies. So petrified we are of this “junk status” concept that even the homeless know that if we continue along this line of economic activity (whatever that is), we are bound to irritate “Moody” (sic). It’s not clear what “junk status” means in practical terms for us ordinary people and the economics and financial gurus dont even think its important to explain it to us. In the absence of what the notion of “junk” really is, we as citizens have decided to conjure-up an image of junk status. It resembles something of a landfill. It suggests we will be thrown onto a rubbish heap and that terrifies the hell out of us. And so whatever it is that is required to keep us off this heap, we shall definately comply with. Perhaps to safeguard ourselves from this constant fear of being junk, we need to shift our mindset to relating better with it. We must see it as recyclable, reusable and from which we can make money.

But back to the rating agencies…..

Our Finance Minister Pravin Gordhan is an untouchable today due to the fact that he holds a special place in the country which if you temper with, collapses the rand and affects Moody’s mood. An investigation into the finance minister is condemned for it may just affect Moodys, Standard and Poor’s and Fitch. By virtue of his power to “sway” these three rating agencies, Gordhan is allowed to show anybody the middle-finger including those investigating him for one thing or another. “Let me do my job,” is all he has to say and we all understand he’s doing this major job of saving us from falling into junk status.

And so it came as a major surprise that the three US-based rating agencies which are supposed to provide investors with reliable information of the riskiness of various kinds of debt were defrauding investors by offering overly favourable evaluations of insolvent financial institutions and approving very risky mortgage-related securities.

S&P paid $1.37 billion in a settlement in 2015 with state and federal prosecutors. Approximately a week ago, Moody’s agreed to pay almost $864million.

Here’s an article from Bloomberg on Moody’s settlement. 

New York/Washington — Moody’s agreed to pay almost $864m to resolve a multiyear US investigation into credit ratings on subprime mortgage securities, helping to clear the way for the firm to move beyond its crisis-era litigation.

Moody’s reached the agreement with the US justice department and 21 states, which accused the company of inflating ratings on mortgage securities that were at the centre of the 2008 financial crisis, the department said on Friday. That penalty is about a third of the $2.5bn that Moody’s earned in the four years leading up to the crisis. S&P Global Ratings, after fighting the US in court for two years, settled similar claims with the US for $1.5bn in 2016.

While Moody’s says it failed to abide by its own standards in rating some securities, it said the settlement does not contain a finding it violated the law or any admission of liability.

“The agreement acknowledges the considerable measures Moody’s has put in place to strengthen and promote the integrity, independence and quality of its credit ratings,” the company said. “Moody’s has agreed to maintain, for the next five years, a number of existing compliance measures and to implement and maintain certain additional measures over the same period.”

Since the financial crisis, the bulk of government settlements have been shouldered by the biggest banks, which have paid more than $162bn in fines and penalties.

The Obama administration has been criticised for years for failing to hold individuals accountable for misconduct leading to the crisis.

Still, the settlement over ratings by Moody’s Investors Service helps the administration move closer to wrapping up investigations of Wall Street firms for their actions leading up to the 2008 mortgage meltdown, a catastrophe that the Financial Crisis Inquiry Commission said wiped out $11-trillion of household wealth. The credit ratings industry has been the target of these investigations into Wall Street for years.

Bank Baulked

The justice department sued Barclays in December for fraud over its sale of mortgage bonds after the bank baulked at paying the amount the government sought in negotiations. The lawsuit is rare for big banks, which typically settle with the government rather than risk drawn-out litigation and a possible trial. The next day, Deutsche Bank and Credit Suisse Group said they had agreed to pay a combined $12.5bn to resolve similar cases, though final settlements with the government have not yet
been announced.

Friday’s settlement calls for Moody’s to pay $437.5m to the justice department and $426.3m to the states. California, an epicentre of the subprime debacle, will get $150m from the agreement, the state’s attorney-general said in a statement.

An after-tax charge of about $702m, $3.62 per share, will be recorded in the fourth quarter of 2016, Moody’s said.

Both Moody’s Investors Service, a unit of Moody’s, and S&P played key roles in Wall Street’s making of toxic, subprime mortgage bonds. While subprime home loans typically go to borrowers with the weakest credit, bonds backed by those mortgages received top-flight, AAA credit ratings. The bonds began coming apart in 2007 as the housing market collapsed, contributing to more than $1.9-trillion in losses at financial firms worldwide during a crisis that almost collapsed the global banking system.

False Top Grades

Investigators in Congress found after the crash that in some cases, credit ratings firms were giving out top grades to junk deals to win business from the banks preparing the securities.

In 2007, Moody’s said in public filings that it had ratings relationships with more than 11,000 corporate issuers, 26,000 public finance issuers, and that it had rated more than 110,000 structured finance securities, comprised primarily of mortgage bonds. As housing prices began to tumble that year, Moody’s downgraded 83% of the $869bn in mortgage bonds it had rated AAA in 2006.

“This crisis could not have happened without the ratings agencies,” the Financial Crisis Inquiry Commission concluded in 2011.

Moody’s remains the second-largest ratings firm after S&P, and together with Fitch Ratings, the three ratings agencies still have more than 96% market share — a bigger hold than the government reported in 2016. In 2007, the triopoly graded 98.8% of bonds outstanding, according to government data.

E-Mail Evidence

In troves of e-mails made public by Congress, S&P executives were caught criticising their own ratings. “We rate every deal. It could be structured by cows, and we would rate it,” read one e-mail exchange between S&P executives. The justice department later included that exchange in its own lawsuit against S&P.

Whereas many outside observers viewed S&P’s e-mails as severely damaging and an indictment in the public perception, few such e-mails from within Moody’s have emerged. That stoked a broadly held view in the industry that the justice department could have a harder time proving misconduct of Moody’s.

“We’ve known for years that conflicts of interest at credit ratings firms were a significant factor in causing the 2008 financial crisis,” Senator Al Franken, a Minnesota Democrat, said when Moody’s announced that it expected to be sued.
“We can’t let Wall Street be above the law,” he said.

Franken has proposed doing away with the rating industry’s payment model, and in the writing of the 2010 Dodd-Frank Act targeted the way that bond issuers pay for their own debt to be assessed. The Securities and Exchange Commission, in its consideration of reform proposals, decided to keep the same business model for the industry in place. Since then, complaints have persisted that ratings shopping is alive and well in mortgage-and asset-backed bond markets.

Bloomberg

4 Comments on "OPINION: Rating Agency Moody’s pays $864m to settle probe into inflated ratings"

  1. Khotso Molekane | January 25, 2017 at 8:03 pm | Reply

    The apostles of capitalism have declared the ratings agencies rogue and yet our finance minister condemns Luther Lebelo for criticising them. He can criticise the ANC, chapter 9 institutions and even the President of the Republic. Frantz Fanon says those who are captured become their master’s true voices in that they echo everything the master says…

    Khotso Molekane

    • Europe wants to do away with those three US-based rating agencies and get their own. Putin threatened to establish a rating agency. And this is the reason. How do you put trust in a guardian who is a fraudster?
      Its not as if these investigations into rating agencies started yesterday. Its ongoing. We cant breath for fear of fraudsters!
      Something fishy – in whose interest is our finance minister operating?
      Kindest

      PK

  2. “While Moody’s says it failed to abide by its own standards in rating some securities, it said the settlement does not contain a finding it violated the law or any admission of liability.”

    Refer to ANC comments about the “black room”.

    It is a disgrace when Institutions wriggle like this. In both cases it leads to reduced confidence in their integrity.

    Just saying.

    • Oh dear John

      You will notice that the line to which you refer is sheer corporate speak. Thankfully, I’ve posted articles on what all the banks have said when they settle.

      Remember the extent to which you have questioned Emerald van Zyl’s work on the basis of race. Was really surprised that you had no comment on the article on JP Morgan’s decision to settle. None of these banks settle for anything else but they know their wrongdoing and understand the reputational damage to their image but more importantly, their back pocket.

      In SA, they dont worry -FNB, ABSA, NEdbank – can all loot because they know there are John Duncans who will protect them and sow confusion.

      On the WarRoom – now clearly spelt out isnt ANC but individuals who are actually anti-Zuma – you’re absolutely correct albeit that you are once again, confusing issues.

      Lets stick to Moody’s and S&P’s settlement. And ask deep questions of why we are beholden to fraudsters – not something you want to tackle dear John.

      Kindest

      PK

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