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Moody's agrees to pay $864 mln for ratings deception

January 14, 2017

Ratings agency Moody's has agreed to a settlement payout with US authorities over mortgage securities fraud that contributed to the 2008 financial crisis. The agreement follows an investigation lasting several years.

Firmenschild Moodys Rating Agentur
Image: AP

Moody's ratings was "directly influenced by the demands of the powerful investment banking clients who issued the securities and paid Moody's to rate them," Connecticut Attorney General George Jepsen said in a statement on Friday.

Twenty-one US states and the Justice Department accused Moody's Investors Services, Moody's Analytics and parent company Moody's Corporation of overvaluing the ratings of securities backed by subprime mortgages and at-risk loans.

Some $437.5 million will go to the Justice Department and $426.3 million to be divided among the states and the District of Columbia.

In March, Moody's agreed to pay $130 million to settle claims by the California Public Employees' Retirement System over allegedly inflated ratings on residential-mortgage bond deals.

In the settlement, the world's second-largest credit ratings agency acknowledged that it hadn't followed its own standards, stating that it had used a more lenient standard for certain financial products and had not made public the differences from its published standards.

"Moody's failed to adhere to its own credit rating standards and fell short on its pledge of transparency in the run-up to the Great Recession," Principal Deputy Associate Attorney General Bill Baer said in a statement.

The long con

The credit rating agencies - whose role is to rate debt securities on the basis of a debtor's ability to pay back lenders - played a key role both in fuelling and then not reining in the US subprime mortgage crisis of 2007-2008, which precipitated the global downturn and long subsequent period of austerity.

Banks made loans to homeowners and then bundled them into securities whose interest payments were guaranteed by those homes.

The banks and other lenders then paid S&P and Moody's to rate the bonds, often being given the highest grade even though many mortgages were granted to people knowingly highly likely to default.

Wall Street
The markets continue to rely on credit ratingsImage: picture-alliance/AP Photo/R. Drew

The Financial Crisis Inquiry Commission concluded in 2011 that "this crisis could not have happened without the 'Big Three' agencies  - Moody's Investors Service, Standard & Poor's and Fitch Ratings," which allowed the ongoing trading of bad debt.

The pools of debt the agencies gave their highest ratings to included over three trillion dollars of loans to homebuyers with bad credit and undocumented incomes up to 2007.

Hundreds of billions of dollars' worth of these triple-A securities were downgraded to 'junk' status by 2010 and the writedowns and losses came to over half a trillion dollars, leading to the collapse or disappearance in 2008-9 of three major investment banks: Bear Stearns, Lehman Brothers and Merrill Lynch.

The US federal government meanwhile was obliged to buy up $700 billion of bad debt from distressed financial institutions.

Out of court 

Standard and Poor's paid a $1.37 billion fine in 2015 for deceiving investors about the quality of subprime mortgages. S&P said at the time it settled to avoid the "delay, uncertainty, inconvenience, and expense” of litigation.

With a third major agency, Fitch, the three ratings firms dominate the bond-rating market with a more than 96 percent share, compared to 98.8 percent in 2007 before the crisis, Bloomberg News reported.

With the District of Columbia, the states involved in the settlement announced Friday are Arizona, California, Connecticut, Delaware, Idaho, Illinois, Indiana, Iowa, Kansas, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Hampshire, New Jersey, North Carolina, Oregon, Pennsylvania, South Carolina and Washington.

jbh/kl (AFP, AP, Reuters)