According to a New York Times report published earlier today, the U.S. Justice Department is investigating Standard & Poor’s (S&P), the nation’s largest credit ratings agency, for its questionable ratings of risky mortgage-backed securities in the run-up to the financial crisis.
Although it is unclear if Moody’s and Fitch’s Ratings, two other influential credit ratings agencies, are also under investigation, the Justice Department inquiry represents the most clear government action yet in tackling the ratings-aspect of the crisis.
The principle target of the investigation is S&P’s ratings practices, which have been increasingly questioned since 2008. As one of – if not the most – prominent ratings agencies in the country, S&P is responsible for assigning ratings to the various financial instruments that are traded on the international markets.
During the housing boom, it became customary for S&P to assign a AAA credit rating (the highest possible rating) to the countless mortgage-backed securities, collateralized debt obligations, and other financial products that banks traded. Those products, as with others, almost brought down the entire U.S. economy with the fall of Lehman Brothers in 2008.
Further complicating matters, S&P was paid, as it always is for its services, for those mortgage ratings by the very companies who owned the securities – sometimes upwards of $100,000. Although S&P always swore to objectivity in its ratings, S&P’s ratings practices have been continually questioned since the crisis, if not investigated.
With the investigation underway, however, speculation is brewing on whether the Justice Department could enact serious change to how the financial markets function. Richard Sylla, a professor at the Stern School of Business at New York University, suggested such potential to the Times.
“I think it would have a major impact if there was a successful fraud case that would suggest there would be momentum for legislation that would force them to change their business model,” Sylla said.
The Justice Department swears, however, that its investigation was launched before S&P’s now-notorious downgrade of U.S. debt from AAA to AA+. Since the downgrade, S&P has been scorned by politicians and media outlets alike, and in addition to inquiries from the Securities and Exchange Commission, possible public hearings in Washington are in the works.