Was S&P downgrade an act of revenge?

http://redtape.msnbc.msn.com/_news/2011/08/09/7321296-was-sp-downgrade-an-act-of-revenge

8/9/2011
Bob Sullivan

You might think Standard & Poor’s has something against the U.S. government, the way the ratings firm treated the nation's credit rating on Friday.

In fact, it does.

It's hard to view the monumental ratings downgrade in context without understanding the long-running feud between the government and ratings agencies. In April, Sen. Carl Levin, D-Mich., issued a scathing 650-page report contending that malfeasance at ratings bureaus like Standard & Poor’s was as much to blame for the housing bubble as any bank, and included a series of smoking gun e-mails that suggested that the firms knew they were profiting from unethical behavior. A little-known section of the Dodd-Frank financial reform bill also hits the rating agencies with new limits destined to undercut their lucrative business; the Securities and Exchange Commission is discussing right now just how to implement the new rules. The public comment period on new rules ended Monday.

Is the timing a coincidence? Or could the ratings downgrade from Standard & Poor’s be viewed as a shot back at a government that's been taking plenty of shots at the ratings industry lately?

To be sure, no one needs Standard & Poor’s to say the U.S. government's coffers are in sorry shape. But this feud over the lucrative and arcane business of granting credit ratings shouldn’t be ignored.

For years, federal agencies and Congress have made attempts to reform the credit ratings business, which on its face is a bit absurd -- part accountancy, part cheerleader, part judge and jury of the financial system. As things stand, firms that want to borrow money from the bond market seek out a seal of approval from companies like S&P, Moody's and Fitch, and pay handsomely for it. The firms say they isolate fee collection from ratings judgment, but the business model is the very definition of a conflict of interest -- and the firms' actions during the height of the housing bubble call into question their ability to keep the ratings business free of profit-driven influence.

"It's like one of the parties in court paying the judge's salary," Levin said recently.

[.....]

Levin's report includes testimony from an endless stream of former employees who say they felt pressure to grant top ratings to new bond issues, lest they lose deals to competitors. In fact, the housing bubble was very, very good for the ratings agencies -- Standard & Poor’s fees from mortgage-related bond issues quadrupled from $64 million to $265 million between 2002 and 2006, the report found.

Internal e-mails from the various firms show that warning bells were repeatedly ignored. A 2006 email from an S&P employee cited in the report said the rating agencies "have all developed a kind of Stockholm syndrome," held captive by banks. Another e-mail cites an employee openly fretting about the agencies facing their "Nixon moment," when the housing bubble finally burst.

The problem hardly began with the overheated housing market, however.

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