U.S. And States Prepare To Sue S&P Over Mortgage Ratings

NEW YORK (TIP): The Justice Department, along withstate prosecutors, plans to file civil charges againstStandard & Poor’s Ratings Service, accusing the firm offraudulently rating mortgage bonds that led to thefinancial crisis, people briefed on the plan said February 4.A suit against S.&P. – expected to filed this week -would be the first the government has brought againstthe credit ratings agencies related to the financial crisis,despite continued questions about the agencies’ conflictsof interest and role in creating a housing bubble.

Several state prosecutors are expected to join thefederal suit. The New York State attorney general isconducting a separate investigation, an official in thatoffice said. The official declined to say whether NewYork State’s action involved other ratings agenciesbesides Standard & Poor’s.Up until last week, the Justice Department had beenin settlement talks with S.&P., these people said.

But thenegotiations broke down after the Justice Departmentsaid it would seek a settlement in excess of “10 figures,”or at least $1 billion, these people said. Such an amountwould wipe out the profits of S.&P.’s parent, theMcGraw-Hill Company, for an entire year. McGraw-Hillearned $911 million last year.During settlement negotiations, the JusticeDepartment held out the threat of a criminal caseagainst S.&P., the people said. Ultimately, thegovernment plans to bring a civil suit, which has alower burden of proof than a criminal case.The case is expected to be brought in California, thesepeople said.

The state suffered disproportionatelyduring the housing bubble, and the government ishoping the venue will yield more sympathetic jurors.The case is focusing on about 30 collateralized debtobligations, an exotic type of mortgage security.According to S&P, the mortgage securities were createdin 2007 at the height of the housing boom.Prosecutors, according to the people, have uncoveredtroves emails by S&P, employees, which the governmentconsiders damaging. Portions of those emails are likelyto be disclosed in the government’s complaint againstS&P, these people said.

In a statement on Monday, S.&P. said it had receivednotice from the Justice Department over a pendinglawsuit. The ratings agency argued any such legalaction would be baseless, since it downgraded plenty ofmortgage-backed investments, including in the twoyears leading up to the financial crisis. It also contendedthat other observers of the debt markets, includinggovernment officials, believed at the time that anyproblems within the housing sector could be contained.

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“A D.O.J. lawsuit would be entirely without factual orlegal merit,” the agency said in its statement. “With20/20 hindsight, these strong actions proved insufficient- but they demonstrate that the D.O.J. would be wrong incontending that S.&P. ratings were motivated bycommercial considerations and not issued in goodfaith.”Shares of McGraw-Hill closed down nearly 14 percenton February 4, at $50.30.

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