To get $1.5 billion settlement, S&P doesn’t have to admit wrongdoing and Justice Department doesn’t have to admit retaliation. Split the dollar positions and it’s a done deal.

Oh, and bring in some jelly donuts when the deal is getting close and you can bridge that last third of a billion difference.

S&P reached a settlement with the Department of Justice and a bunch of states over the ratings S&P gave to mortgage securities before the financial crisis. Top line settlement amount is $1.5B. See Wall Street Journal article, S&P to Pay $1.5 Billion to Resolve Crisis-Era Litigation.

Be advised the ridicule and abuse in this post will soon flow thick…

Settlement negotiations

Starting point from the DoJ side was $5B and acknowledgement of wrongdoing.  S&P wanted under a billion and acknowledgment of the whole deal being in retaliation for S&P downgrading the federal credit rating.

My version of the back and forth haggling that got them to common ground:


Drop admission of guilt.

DoJ: Okay, $3.2B. S&P: We’ll break the billion mark.

DoJ drop to $1.5B and S&P up to $1.2B.

Bring in those yummy donuts. You know, the ones with the jelly filling and sprinkles. Then drop the retaliation claim and agree on $1.3B.

Done? Yup.

Everyone’s happy. Nobody has to admit they did anything wrong. Both claim complete, total vindication.

That’s my loose paraphrase. For the unabridged version, see the WSJ article How the Justice Department, S&P Came to Terms.

A different look at the sequencing

Days after S&P downgraded the federal credit rating, then Secretary of the Treasury Timothy Geithner allegedly made an angry call to the CEO of S&P’s parent.

In February 2013, a WSJ editorial pointed out that the feds sat on the case for five years which leads to the amazingly close time of the litigation following the S&P downgrade of U.S. securities. See Payback for a Downgrade? The feds sue S&P but not Moody’s for pre-crisis credit ratings.  DoJ still hasn’t sued either Moody’s or Fitch.

Feds: We’re gonna’ be watchin’ you.

The results of being watched:  Litigation with a demand for $5B to cover losses by all those federally insured banks and admit wrongdoing, opening the door to never-ending additional settlements.

A Bloomberg article says the hard-line position of the DoJ continued until a couple of months after a federal judge ruled S&P could get discovery to see documents from inside DoJ. That allowed S&P to search for proof of retaliation. A few months later DoJ wanted to talk settlement. See S&P Ends Legal Woes Paying $1.5 Billion Fine to U.S., States.

Feds: Uh, oh. They’re gonna’ get to see our files. Time to settle. Get ’em on the phone. Now.

A little bickering over amounts and a box of donuts later, there is a settlement.

How the settlement pie is sliced

Let’s look at the settlement, according to the first WSJ article above:

  • $687.5M – Department of Justice cut (great PR and looks superb on the ol’ resume)
  • $687.5M – 19 states and DC government (a bit of help for the budget shortfalls)
  • $125.0M – CalPers

Since that adds up to the $1.5B top line settlement, that leaves the remainder to be distributed as follows:

  • $0.0M – the credit union that is the named harmed person in the original suit
  • $0.0M – banks and any other insured institutions who either suffered so much harm for an unending stream of those patently fraudulent securities or who bought perfectly good paper, depending on who you listen to
  • $0.0M – individual investors
  • $0.0M – other remediation

Federally created oligopoly

Remember that S&P, Moody’s, and Fitch are an oligopoly of rating agencies. They are the only raters than can be used for public offerings. Remember also that it is the feds, in the person of the SEC, who created and enforces this oligopoly.

I’ve not seen any indication there will be any interference in S&P’s lucrative participation as a crony in the manufactured oligopoly.

Actually makes sense S&P has to pay up

Banks and insurance companies can only buy high rated paper. I’m guessing pension plans and university endowments with their zillions of dollars also only buy high rated paper.

So the three rating agencies make their living by rating paper so that institutions can buy it. With that high rating, the institutions don’t have to do so much as half a minute of their own due diligence on what they buy. If it’s rated quintuple A plus plus (or better), just look at the yield, match your maturity target, and buy.

That’s all I did when I ran the tiny securities portfolio at a small bank. Don’t recall ever doing any due diligence and never heard a word from my boss about doing so. I never looked at a prospectus.  Brokers who called never mentioned ratings.

In a few years of auditing banks, S&Ls, and an insurance company while at Big 8 firms, I don’t recall ever hearing so much as one comment from anyone ever about doing due diligence before buying paper. If it’s rated, it’s good.

Since investors never look at the quality of what they buy, they are essentially relying on the rater to vouch that it is a good investment. So that pretty much puts S&P in the role of an insurer.  If it goes sour, the fault obviously belongs to the rater. In our society, that means they should pay if anything goes wrong.

So from that perspective, it makes absolute sense that S&P should pay if zero-down, zero-doc, 1%-interest-rate-so-you-can-qualify loans go bad. They are the insurer.

(Should I explain the point of this ridicule is that perhaps, just perhaps, institutions that bought the MBSs that went bad ought to have known they were buying junk mortgages? Maybe they ought to have looked at the prospectus?)

Moral of the story?

The whole thing reminds me of Sam Antar’s comments that enforcement efforts since the Great Recession are a tax levied by various levels and agencies of government.

Not sure there is a clear moral to the story, but here is one possibility: Don’t bite the hand that feeds you.

Or rather:

Don’t bite that federal hand that keeps you fed and securely in your place as a crony capitalist or there can be some nasty payback.

On the other hand, perhaps the moral of the story is that if you make your fortune playing in a government created oligopoly, you can expect to get burned if the feds need to blame someone.

Okay, that’s enough ridicule and sarcasm for the week.

What do you think? Comments with a minimum amount of politeness welcome.

Update:  A WSJ editorial on 2/8 clarified some information for me: A Poor Standard of Justice (get it? Standard & Poor. Well, I thought it was clever).

A call was made from Treasury Secretary Geithner to the McGraw Hill CEO and it took place minutes after a meeting between Mr. Geithner and the President. Hold that thought.

Consider this info:

Court rulings had required Justice to turn over numerous internal documents, and S&P’s lawyers told the government they would next seek documents related to why Moody’s wasn’t charged.

Down the road were requests for sworn testimony from Mr. Geithner and for documents reaching into the Executive Office of the President. The judge made clear that such disclosures would be compelled only if S&P had exhausted all other avenues to obtain information and could overcome executive privilege.

So S&P has to work through all the documents they have now. Then they may request permission to depose Mr. Geithner. Then they may start an argument to clear the really high hurdle of executive privilege to see what conversations took place with anyone in the White House, including that meeting preceding the fateful phone call.

My point? Disregard the DoJ comment that a few hundred million pages of material has been provided thus far under discovery. The really juicy stuff, which is where any smoking guns would be buried, is in material not yet subject to discovery.

With discovery progressing and getting closer, DoJ really wanted to settle. Bring in the jelly donuts, split the difference, and declare complete victory.

Discovery is done. Over.

We will just have to guess and speculate whether there are smoking guns or not.

Leave a Comment

Your email address will not be published. Required fields are marked *