Skip to main content

S&P faces lawsuit over high credit ratings: Why now?

By Ramy Inocencio and Kevin Voigt, for CNN
February 5, 2013 -- Updated 0534 GMT (1334 HKT)
A sign for Standard & Poor's rating agency stands in front of the company headquarters in New York, September 18, 2012.
A sign for Standard & Poor's rating agency stands in front of the company headquarters in New York, September 18, 2012.
STORY HIGHLIGHTS
  • U.S. government lawsuit against S&P would be first for a credit ratings agency
  • S&P parent company, McGraw-Hill, plunged 13.78% in Monday trading
  • NYT: $1 billion settlement talks recently fell through between S&P, Justice Dept.
  • S&P: Justice Department lawsuit 'without factual, legal merit'

Hong Kong (CNN) -- In a first for a U.S. credit ratings agency, Standard & Poor's has received official notice from Washington that it will face a civil lawsuit over imprecise ratings -- now criticized as being too high by analysts, U.S. lawmakers and even S&P itself -- of mortgage-backed investments that eventually contributed to the 2008 financial crisis.

Many of those investments received AAA ratings, a grade which implies highest safety and least risk, but imploded as the U.S. housing bubble burst.

As S&P awaits further word from the U.S. Department of Justice, ratings agencies Moody's and Fitch will be watching to see if they are next.

Standard & Poor's parent company, McGraw-Hill Companies, plunged 13.78% in Monday trading, after investors learned of the Department of Justice's intent to file suit. The company's share price fall was its biggest one-day drop since the stock market crash of 1987.

French credit downgrade blame game
Markets overreacting to Moody's ratings?
S&P's Chambers explains euro downgrades

It is unclear as to why S&P is the first to be targeted but according to a recent New York Times report, settlement talks between the ratings agency and the Department of Justice fell through in the past two weeks. The article also reported that prosecutors demanded S&P pay a $1 billion penalty and admit to wrongdoing.

In a statement, S&P has said the expected Department of Justice is "entirely without factual or legal merit."

Who are the credit rating agencies?

The "big three" are Standard & Poor's, Moody's Investor Services and Fitch Ratings. All originated in the United States, although Fitch has headquarters in New York and London.

What do they do?

Before you can get a credit card, banks run a credit check on you. Similarly, the ratings agencies run credit checks on companies, countries and financial products -- and banks themselves.

The agencies assess their ability to pay off loans or investments and then rate them on a sliding scale, ranging from AAA to D. In the case of government bonds, anything that slips to BB+, as was the case with crisis-hit Greece, is considered a "highly speculative" investment, or "junk bonds" in the parlance of the markets.

Why do the agencies wield such power?

Investors across the world look to credit ratings agencies to judge where to place their bets in the market. For governments, the ratings agencies have a lot of power over the popularity of bonds: cash given to governments like Greece by investors that, over time, will pay a return on the original investment -- unless the government defaults.

The downgrade of Greece signaled Standard & Poor's belief that Greece has a higher likelihood to default on investments. It caused investors to lose their appetite to invest in bonds from Greece, which then imperiled the nation's ability to pay down its deficit.

How are ratings agencies paid?

Historically, they were created to give investors an unbiased assessment of investments and investors paid for access to the ratings. In the 1970s, however, credit rating agencies started charging the issuers of new investments fees for ratings. In 1975, U.S. legislators -- fearing a proliferation of unscrupulous ratings agencies -- designated Standard & Poor's, Moody's and Fitch as the only ratings organizations banks and brokers could use to evaluate the credit worthiness of their products.

Since 2011 however, European regulators have begun to push back against U.S. ratings agencies, blaming them for adding volatility to the sovereign debt crisis by lowering their ratings of troubled eurozone nations -- thereby pushing up borrowing costs.

What are the complaints against the firms?

Critics complain the agencies have lost their ability to independently judge the risk on certain investments -- especially in light of AAA ratings given to mortgage-backed securities that imploded when defaults on U.S. home loans shot up, triggering the 2008 financial crisis. Critics also note that the agencies are paid by the very entities they rate, raising questions about their trustworthiness.

Lawmakers in the United States, the European Union and other countries around the world are now reviewing regulations on the credit ratings agencies. Credit ratings agencies, too, have revamped their procedures and have argued their ratings are merely opinions -- it's up to the markets to decide.

ADVERTISEMENT
Part of complete coverage on
June 17, 2014 -- Updated 1206 GMT (2006 HKT)
London is promoting its tech stars to shows it can compete with Silicon Valley. Here are five companies to watch.
June 18, 2014 -- Updated 1222 GMT (2022 HKT)
It's not easy being Jordan and it is about to become even more difficult, again.
June 18, 2014 -- Updated 1502 GMT (2302 HKT)
At the last football World Cup, it was all about 3D. This time around, it's nothing less than 4K.
June 5, 2014 -- Updated 1416 GMT (2216 HKT)
Bob Mazzer has photographed inside London's Tube network for 40 years. He's captured history.
June 13, 2014 -- Updated 1529 GMT (2329 HKT)
Iraq produces 3.3 million barrels per day and has the world's fourth-largest oil reserves. But the current crisis is putting all this in danger.
June 18, 2014 -- Updated 1222 GMT (2022 HKT)
Sandwiched in between Iraq and Syria, Jordan's destiny seems to be one of a constant struggle for survival. John Defterios explains.
June 16, 2014 -- Updated 1314 GMT (2114 HKT)
The gas standoff between Russia and Ukraine could have a knock-on effect on Europe. Explore this map to find out why is the EU nervous.
June 5, 2014 -- Updated 1416 GMT (2216 HKT)
Bob Mazzer has photographed inside London's Tube network for 40 years. He's captured history.
June 17, 2014 -- Updated 1206 GMT (2006 HKT)
The UK capital promotes its tech stars and shows it can compete with Silicon Valley. Here are five companies that pitch to make it big.
June 3, 2014 -- Updated 0956 GMT (1756 HKT)
Banksy has condemned an exhibition of his work after organizers defended their decision to remove his art from public spaces.
June 3, 2014 -- Updated 1029 GMT (1829 HKT)
As debate rages over whether Banksys should be for sale, we direct you to the ones you can still see on the streets.
June 2, 2014 -- Updated 1338 GMT (2138 HKT)
While Ukraine's fight for freedom gets bloodier by the day and Russia faces the West's cold shoulder, one oligarch is using art to get his message across.
May 30, 2014 -- Updated 2114 GMT (0514 HKT)
Index on Censorship's Jodie Ginsberg argues the "right to be forgotten" decision is too woolly.
May 29, 2014 -- Updated 1613 GMT (0013 HKT)
Andy McNab says being a psychopath makes us better at business, life and love. Could he be right?
May 28, 2014 -- Updated 1720 GMT (0120 HKT)
Google has revealed a prototype of its latest driverless car -- and this one doesn't even have a steering wheel.
May 30, 2014 -- Updated 1024 GMT (1824 HKT)
CNN's Nina dos Santos speaks to the mothers of successful children and asks them: What's the secret of bringing up a winner?
May 26, 2014 -- Updated 1613 GMT (0013 HKT)
Far-right and far-left parties across Europe caused a political "earthquake," with a string of victories in voting for the European Parliament.
May 26, 2014 -- Updated 1623 GMT (0023 HKT)
CNN's Fionnuala Sweeney speaks to Mihaela Carstei about the $400B gas deal recently struck between Russia and China.
May 21, 2014 -- Updated 0818 GMT (1618 HKT)
The EU is struggling to identify its vision after financial crisis. The European elections are key, and Nina dos Santos says the union needs a new vision.
May 26, 2014 -- Updated 1135 GMT (1935 HKT)
CNN's Nina Dos Santos sits down with Elon Musk's mother Maye, who tells her the story of her family and their success.
May 7, 2014 -- Updated 1410 GMT (2210 HKT)
Boko Haram attacks have shifted the focus at the World Economic Forum hosted by Nigeria, CNN's John Defterios explains.
May 20, 2014 -- Updated 2219 GMT (0619 HKT)
Russian oligarch is set to lose half his wealth after being ordered to pay his former wife $4.5 billion in a divorce settlement.
April 2, 2014 -- Updated 1324 GMT (2124 HKT)
China's ultimate goal is to reach a wide-ranging trade agreement with the EU. The EU hopes to persuade China to open its markets.
ADVERTISEMENT