Je Suis S&P: Government’s Chilling Effect on Credit Rating Agencies

When the Department of Justice sued the credit rating agency Standard & Poor’s, I was a bond analyst at its competitor, Moody’s Investors Service. While relieved to avoid government crosshairs, we had no reason for schadenfreude because we had no guarantee it wouldn’t be us next. That threat hasn’t materialized for Moody’s, though recent news that S&P might settle with DOJ for $1 billion after a contentious two-year battle is troubling for free speech advocates.

S&P alleges the feds targeted the firm in retaliation for a downgrade of U.S. debt. If true, it is a chilling precedent for any writer or analyst expressing opinions supposedly protected under the First Amendment. As my Competitive Enterprise Institute colleague John Berlau discusses, the government also targeted a much smaller credit rating agency, Egan-Jones, which also downgraded U.S. debt, while leaving alone both Moody’s and Fitch, which did not downgrade American government debt.

Moody’s outperforms S&P in various awards and market analyses. But based on conversations with former colleagues and acquaintances who have worked at S&P, my understanding is that the two rating agencies have similar approaches to the rating committees under fire by DOJ.

Rating committees convene prior to publication of a credit rating agency’s opinion. While my own rating committees concerned fundamental credit analysis, and the committees in question were for structured products, I’ve also attended those committees, which are comparable. Sometimes the conversations are intense, and the vote of the most junior analyst carries the same weight as the most senior member. Sometimes committees can stretch over long periods, days even, as more information is gleaned in trying to reach the best verdict. Sometimes votes are split, sometimes they are unanimous, and sometimes a re-vote is required in case of a draw.

Government investigators appeared concerned that analysts did not hold unanimous viewpoints—that some disagreed with the AAA ratings assigned to various housing-related structured products, believing they were riskier than that highest designation. Yet the process encourages dissent and debate, so it’s no surprise there would be alternative estimations. This is analogous to a newspaper editorial board where members hold disparate viewpoints, yet join together to speak as one voice in unsigned editorials.

Regardless, we now know the ratings were incorrect. But according to arguments by S&P lawyer Floyd Abrams, a First Amendment expert, they were identical to ratings from at least one other rating agency and echoed sentiment from the Federal Reserve and Treasury Department.

As The Wall Street Journal points out, credit rating agencies and banks are caught in a dog-chases-tail scenario because the government mandates banks hold securities with high ratings, arguably contributing to the banks’ losses, when they act on the AAA stamp of approval. And the rating agencies themselves are merely expressing opinions, not forcing banks to hold anything at all. So DOJ could wipe out all of S&P’s annual profit simply for expressing constitutionally protected viewpoints that triggered government-mandated bank actions.

It all seems an elaborate shell game, with S&P shareholders the immediate losers. Longer term, it’s in the interest of other financial institutions, and even the media, to speak in defense of the free flow of ideas that is at risk under this Orwellian investigation.