A lawsuit was filed in federal court Feb. 4 by the U.S. Justice Department against Standard & Poor’s for massive fraud in its ratings of securities comprised of subprime, Alt-A and other exotic mortgages.
Subprime mortgages are predatory loans with interest rates at least 3 percent higher than the standard rate, usually sold to people of color in a calculated, racist move. Alt-A mortgages are no- or low-document loans with 100 percent financing; they have features like minimum payments below actual interest rates, which eventually adjust upward leaving the borrower unable to make payments.
S&P, along with Moody’s and Fitch, are the leading national registered security rating organizations according to the U.S. Security and Exchange Commission. They issue credit ratings reflecting their opinion of the “creditworthiness of a particular company, security or obligation.” These ratings determine a company’s ability to issue bonds, securities and other investment instruments, and affect these transactions in a multitude of ways. (SEC Report on the Role and Function of Credit Ratings Agencies, Jan. 2003.)
Mortgages are bundled together into security instruments which are sold to investors. The security instruments’ credit worthiness is determined by the likelihood that the mortgages comprising them will actually be paid by homeowners.
The Justice Department complaint alleges that from 2004 to 2007, S&P gave its highest investment grade to mortgage-backed securities comprised of subprime and Alt-A mortgages, despite knowing that a high percentage of these fraudulent mortgages were likely to default or fail. As a result, the security instruments ended up being bankrupt, leading to the 2008 financial collapse which taxpayers have been paying for with bank bailouts ever since.
The reason for this fraudulent conduct by the credit ratings agencies is that, rather than being independent evaluators, S&P and Moody’s are profit-making corporations that get paid a fee for every financial instrument they evaluate. This fee is paid by the very banks issuing these securities. By giving high ratings to subprime mortgage securities despite knowing they would ultimately fail, S&P was selected as the credit ratings agency by banks and derived huge profits as a result.
High profits & destroyed communities
The Justice Department complaint notes that from 2004 to 2005, the revenue and operating profits of S&P increased 16.8 percent and 21.4 percent respectively, and from 2005 to 2006 revenues and profits increased 14.4 percent and 18 percent respectively. The tremendous growth in profits and revenues was a direct result of the company’s volume ratings of subprime and Alt-A mortgage securities.
The Senate Select Committee Report on Wall Street and the Financial Crisis, issued April 13, 2011, notes that the rate of profit for banks on subprime mortgage securities was 7.5 times higher than on fixed-rate mortgage securities, and the rate of profit for Alt-A mortgage-backed securities was twice as high. The rate of profit was too good to resist. Every major bank got involved in writing these mortgages despite knowing they would ultimately fail, which was facilitated by the ratings agencies’ collaboration in fraudulently legitimizing these loans.
The Senate committee report notes that S&P was joined by other credit ratings agencies in this practice. The report points out that government regulators ignored this massive bank swindle, which calls into question whether this new lawsuit is meant to cover up the real extent of the fraud that was perpetrated.
While investors suffered as a result of these fraudulently bundled mortgage-backed securities, the real victims were the millions of homeowners placed into loans they never would be able to pay, and who lost their homes as a result of the ensuing foreclosure epidemic.
Despite the massive fraud perpetrated by the ratings agencies, they continue to hold a tremendous sway over the economy. For example, the city of Detroit, faced with a decline in tax revenue in large part due to 150,000 mortgage foreclosures in a five-year period, was induced into mortgaging the city treasury by selling bonds and engaging in credit default swaps backed by tax dollars. The banks placed onerous conditions into these financial instruments, including provisions for default and immediate repayment if the credit rating agencies, S&P and Moody’s, lowered the city’s bond rating.
When the city’s bond rating was lowered in 2009, Detroit was subject to an immediate penalty of $400 million, payable to the same banks which profited by selling fraudulent subprime mortgages with the blessing of the credit ratings agencies. Detroit’s bond rating was lowered again in 2012, resulting in hundreds of millions of dollars more paid to the banks, funded by massive cutbacks in city workers’ jobs and wages and elimination of basic city services.
The time is overdue for the working class and oppressed to rise up against the banksters and their credit agencies, and to overthrow the capitalist system which criminally and fraudulently robs the people and destroys communities in its mad drive for profit.