Is Eric Holder’s “See No Evil, Hear No Evil” Department of Justice finally getting serious about investigating fraud on Wall Street? At first glance, it would seem so, given the news that the Department of Justice has filed civil fraud charges against the nation’s largest credit-ratings agency, Standard & Poor’s, accusing the firm of inflating the ratings of mortgage investments and setting them up for a crash when the financial crisis struck.
On the one hand, there is no question that without the credit rating agencies the Wall Street guys would not have been able to pull off this colossal heist against the American people, and the ratings agencies cannot be excused. In fact, Standard & Poor’s employees openly joked about the company’s willingness to rate deals “structured by cows” and sang and danced to a mock song inspired by “Burning Down the House” before the 2008 global financial collapse, according to the DOJ lawsuit. On the other, the ratings agencies are simply the gift wrappers. DOJ has yet to go after the banksters who created these packages in the first place and who seem to be in the clear as a result of a series of unconscionably low settlements recently reached with the Justice Department.
I suppose we ought to be grateful for these baby steps in the right direction. The ratings agencies themselves have admitted to US government enquiries recently that they took money in return for ratings that were not based on any fundamental assessments other than the cash they were being paid. They have lied about the risk of default in many corporate cases and then marked down debt when the game was up further destabilizing the financial system. Hence, to say that their behavior was at the heart of the great crisis is absolutely correct.
Of course, that inevitably begets the obvious question: what took you so long and why leave it at S&P? As early as September 2004, the FBI warned that there was an “epidemic” of mortgage fraud and predicted that it would cause a financial crisis if it were not stopped. It was not contained. Everyone agrees that the mortgage fraud epidemic expanded massively after the FBI warning and still not one Wall Street figure of any note has gone to jail.
Under Treasury Secretary Geithner, and the Keystone Cops of the Department of Justice, led by Eric Holder and Lanny Breuer, we established a doctrine of “too big to jail” for the very institutions which perpetrated massive frauds on millions of Americans. Those who called for regulations that would take even that most minimal of steps necessary to reestablish the rule of law and restore our nation’s democracy and financial stability were essentially ignored. Geithner’s express rationale was that the financial system's extreme fragility made vigorous investigations of the elite frauds too dangerous, in effect giving the banksters a get-out-of-jail-free card and in effect enshrining crony capitalism and imperiling our economy, our democracy, and our national integrity.
So what’s changed? Well, obviously one has to ask if the departure from Treasury of Mr. Geithner, along with the ignominious resignation of the odious Lanny Breuer at the DOJ heralds a new approach, or are there are other motives in mind?
There is a school of thought which suggests that this lawsuit is an attempt by the US government to intimidate the ratings agencies against any further US debt downgrades. If so, it’s a pretty stupid shakedown. The truth is that sovereign governments like the US empower these agencies simply by listening to them, in the same way they listen to the IMF, and put the interests of these undemocratic and crooked agencies ahead of their own national interests.
In our economy, the Federal Reserve sets interest rates, not the bond markets, although the latter may impact on the prices and yields of longer-term investment assets.
But in general, the Bank of Japan showed in the period from the mid-1990s onward that they can keep interest rates very low (zero) and issue as much government debt as they wanted even in the face of consistent credit rating agency downgrades, by organizations of dubious ethics.
So when a government stands up to the agencies, the impact is likely to be minimal. Here's another idea: they can just outlaw them. This may seem draconian, but consider that the FDIC puts criminally run banks out of business all of the time. It’s hard to see why the ratings agencies, as their enablers, should be treated any differently. The reality is that the so-called Big Three – S&P, Fitch and Moody’s -- were all criminally incompetent. They prostituted themselves in a pay-to-play scheme in which they would give to garbage securities any rating sellers desired, so long as the assessed fees were sufficiently high.
At a very minimum one would have thought we could introduce reforms that would align incentives, with buyers of rated securities paying for assessment of risk. The ratings agencies like S&P never actually looked at any of the mortgages that collateralized the securities they rated (it was all too pedestrian for them). As we now know from internal emails, they neither checked the loan tapes (the data provided by borrowers), nor the expertise in rating mortgages (all of their experience was in rating corporate and government debt), nor took the time to assess credit risk. And they have never understood how to rate sovereign government debt, failing to consider that there is no default risk for a country that issues its own currency. And yet the ratings agencies have provided higher ratings to low-quality NINJA loans (short for No Income No Job No Assets) than to countries with riskless sovereign debt!
Sadly, Congress and the Obama administration, in their deliberations to “reform” our financial system via Dodd-Frank, did nothing then to reform the ratings agencies. They worried that somehow, by introducing widespread reforms to the ratings agencies, they would reduce business for the monopolies. Hence, the bill contains no significant changes required of ratings agencies, which are encouraged to continue pimping their ratings.
Perhaps this lawsuit signals a chance. In any case, it is time to wean the private financial markets off these agencies by eliminating their role as gatekeepers to the thousands of financial products on which they provide in their Papal-like declarations. It's time to leave it to individual institutions themselves to do their own credit analysis. We should go further and simply make them illegal, and mandate that all financial institutions with access to the Fed’s lending as well as any financial institution with Treasury guarantees on liabilities (such as FDIC insurance) would be prohibited from selling or buying any derivatives. All assets would be carried on bank books through maturity -- with full exposure to interest rate, currency and default risk. That provides the correct incentives to protected lending institutions as opposed to relying on some flimsy rationale provided by a highly conflicted rating agency.
If our pension funds, and financial fiduciaries truly think they need an objective third-party agency to rate Wall Street paper, then at a minimum Congress and the President should be required to purchase ratings services from arms-length professionals, with the top three monopolists specifically excluded because they have demonstrated their inability to provide unbiased ratings. Furthermore, make ratings agencies liable for improper ratings, imposing a fiduciary responsibility to actually evaluate any instruments that are rated.
Better yet, prohibit banks and other government-protected institutions from buying this crap in the first place or prosecute them to the full extent of the law for using them to rip off millions of American consumers. If we’re going to go after the gift wrappers, we might as well after the original source of the fraud in the first place as well. In that regard, one can hope that yesterday’s lawsuit signals a fresh approach by the Holder Department of Justice, but don’t hold your breath waiting for it.