DOJ, States To Sue Moody’s Credit Rating Agency For Role In Mortgage Meltdown

Image courtesy of Alec Tabak

What drove the mortgage bubble in the years leading up to the 2008 financial crisis wasn’t just ill-prepared home-buyers signing on to subprime, adjusted-rate mortgages they couldn’t afford, or the lenders who effectively gave up on underwriting these loans so as to bundle and resell as many of them as possible. There were also credit rating agencies that gave these mortgage-backed bonds the seal of approval, even when they were worthless.

In a filing [PDF] this morning with the Securities and Exchange Commission, Moody’s Corp. — the nation’s second-largest rating agency — revealed that lawsuits are likely pending from both state and federal agencies over the company’s ratings on toxic mortgage-backed bonds.

According to Moody’s, the company received a letter from the Department of Justice on Sept. 29 that federal prosecutors are preparing a civil complaint “alleging certain violations of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) in connection with the ratings MIS assigned to residential mortgage-backed securities and collateralized debt obligations in the period leading up to the 2008 financial crisis.”

In addition to the DOJ letter, Moody’s disclosed that “A number of states attorneys general have indicated that they also expect to pursue similar claims under state law, which claims may include additional periods, theories, asset classes or activities.”

The filing did not disclose which states have thus far mentioned the possibility of litigation, or if any of these states are working together to bring a joint action.

Moody’s and competitor S&P have long been suspected of giving inflated ratings to mortgage-backed securities during the housing boom. The theory was that the agencies gave top ratings in order to keep doing business with the banks and lenders that were selling them. However, once homeowners began to default on these loans, it became clear that the mortgage-backed securities had often not merited the ratings they received.

S&P settled with the U.S. last year, admitting no wrongdoing but paying a $1.5 billion penalty.

Sen. Al Franken (MN) has remained critical of the rating industry, arguing that SEC reforms instituted since the collapse have not halted the practice of “rate-shopping,” wherein the bank does business with the agency that will likely give their securities the most favorable rating.

“During the 2008 financial meltdown, Wall Street cut the ground out from under millions of hardworking Americans who lost their jobs, homes, and retirement savings,” said Franken in a statement. “And at the heart of the crisis was an inherent conflict of interest between credit rating agencies — like Moody’s, Fitch, and S&P — and big financial institutions like banks.”

He has pushed for an independent board, overseen by the SEC, to assign ratings to the agencies. The hope is that the agencies would then not worry about losing business if they provided less-than-ideal ratings.

“We can’t let Wall Street be above the law,” says the senator. “We must have a fair and honest credit rating industry in this country, and I am glad the Department of Justice has pursued this matter.”

Want more consumer news? Visit our parent organization, Consumer Reports, for the latest on scams, recalls, and other consumer issues.