Wall Street reacts to credit rating downgrade. M. Spencer Green/AP
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In April 2002, Georgia Gov. Roy Barnes won legislative approval for a law to hold Wall Street accountable for bankrolling predatory lending. After the Democrat lost reelection that fall to Republican Sonny Perdue, the finance industry launched an all-out assault on the provisions of the law that held mortgage investors liable if they bought fraud-tainted home loans.

One of the defining moments in the legislative fight came when Standard & Poor’s, the giant debt rating company, announced it would no longer rate securities that might be backed by loans covered by the Georgia law, raising the specter that investors would cut off the flow of money into the state’s mortgage market and cripple its ability to provide credit to homeowners.

In March 2003, the legislature buckled to pressure and passed amendments shielding mortgage investors from liability. Other states saw what happened in Georgia and shied away.

“It’s outrageous,” Barnes, now an attorney in private practice, told iWatch News. “The same crowd that was telling us that predatory subprime loans were AAA credit is now telling us that the credit of the United States is not AAA.”

The “overbearing bureaucracy” that caused the last collapse, Barnes said, now may be “on its way to causing another collapse.”

S&P’s role in the financial crisis is coming under increasing attention after its decision last week to downgrade the U.S. government’s credit rating. Critics charge that S&P and other credit rating companies played an important role in lobbying to prevent Wall Street from being held accountable for abusive practices—and by providing their seal of approval to toxic mortgages that helped spark America’s economic woes.

In a news conference, S&P defended its downgrading of the U.S.’s credit rating, calling Washington’s high-stakes battle over the federal debt ceiling a “debacle.”

An S&P spokeswoman, Patricia Rockenwagner, told iWatch News on Monday: “Our analysts convey independent opinions about creditworthiness to the market using rigorous analytical criteria. Our lobbyists express views about public policy to the government. There is a strict firewall that separates the two—always has been, always will be.”

$10 Million Spent on Lobbying

An iWatch News analysis of lobbying data indicates that the three largest rating agencies combined to spend more than $10 million on lobbying in the last nine years.

S&P, Moody’s Investors Service and Fitch Ratings have all come under scrutiny as officials in Washington have attempted to prevent a downgrade of the U.S. government’s credit rating last week. While Moody’s and Fitch stood pat, S&P downgraded the federal government’s credit rating from “AAA” to “AA+”. The downgrade sent stocks into a tumble, with the Dow dropping more than 630 points on Monday.

Despite their power over world economies, credit rating agencies are private enterprises, with no prohibition on lobbying at either the federal or state level. An analysis of data collected by the Senate Office of Public Records revealed:

  • The three firms spent more than $10 million combined on federal lobbying since the start of 2002. Moody’s was the most active, spending about $7.3 million on lobbying, followed by Fitch with about $1.8 million and S&P with about $1.5 million.
  • The companies’ spending on lobbying has increased significantly since 2008, totaling over $6 million. The increase was mostly driven by Moody’s and Fitch; S&P has remained relatively consistent.
  • While the three companies do not have political action committees, individuals working at these agencies have contributed about $190,000 to political causes since the start of 2005. The top recipients of those contributions: President Barack Obama (at least $33,000), former Democratic Rep. Joe Sestak and the Democratic National Committee (at least $17,000 each), the presidential campaign of Sen. John McCain (at least $16,900) and the various campaigns of Hillary Clinton (at least $12,500), now the Secretary of State.

Much of the increase in lobbying from these agencies came during the fight over the Dodd-Frank financial reform bill.

“The rating agencies were visiting every office,” said Marcus Stanley, a former U.S. Senate staffer who is now policy director for Americans for Financial Reform, which advocates for tougher financial regulation. “They knew that their profits were at stake.”

Last year, Sen. Al Franken, a Minnesota Democrat, authored a bill that would have created a government middleman to dole out rating assignments, but it was dropped in committee. At the same time, ratings agencies were working hard to limit the damage of Dodd-Frank, which contained provisions making it easier to launch a lawsuit against the companies if they were found to be “grossly negligent.”

A spokesperson for Moody’s didn’t respond to questions. Daniel Noonan, Fitch’s Managing Director for Communications, said: “Fitch sometimes utilizes lobbyists, but such corporate matters are completely separate from and have zero influence upon our analytical groups that assign ratings.”

iWatch News has written extensively about the mortgage crisis and its impact on the economy, and last week disclosed that the nation’s largest mortgage servicers had donated more than $8 million to political candidates and committees since the start of 2009.

‘A Line in the Sand’

Not reflected in the lobbying data is how rating agencies can influence policy decisions by wielding their power to provide, or withhold, their approval to governments, companies and entire markets.

During the 2003 battle over the Georgia Fair Lending Act, S&P wasn’t alone. Even before S&P took a public role in the fight, dozens of mortgage lenders announced they were pulling out of the state, saying that excessive regulation was making it impossible for them to keep doing business there.

Still, S&P played a pivotal role.

In early 2003, the company announced it would no longer rate pools of loans that might be impacted by the law. S&P said it believed that the law’s tough investor-liability provisions made it impossible to insulate investors and Wall Street banks from the risks of huge financial penalties for predatory lending. If they bought loans that violated the law, S&P Frank Raider said at the time, investors could be hit with huge jury verdicts. “There’s no way to quantify the punitive damages,” the executive said. “We cannot issue a rating on the underlying collateral.”

S&P’s competitors, Fitch and Moody’s, followed suit. They announced that they would give heightened scrutiny to pools of loans that included mortgages from Georgia. The trade press also reported that, in the wake of S&P’s announcement, Lehman Brothers and other Wall Street firms had begun cutting off lines of credit to lenders that had continued to originate loans in Georgia.

During the legislative tussle, Georgia lawmakers relied heavily on S&P for help in crafting the legislation. S&P vetted proposed amendments and made recommendations for how the legislature could change the law to satisfy the rating agency’s concerns.

Amid the fight, the Atlanta Journal-Constitution reported that “State officials and Standard & Poor’s reached a compromise agreement” that “could pave the way for the credit-rating agency to resume rating securities backed by Georgia home loans.” It noted that Senate Banking Committee Chairman Don Cheeks, a Republican, and representatives of Democratic Lt. Gov. Mark Taylor “spent hours in negotiations” over a two-day period with S&P.

The deal paved the way for approval of the amendments to the fair lending law. The amendments protected investors from class-action lawsuits and put limits on the damages that individual borrowers could collect from investors. Perdue signed the modifications into law in March 2003.

Georgia’s actions had impact far beyond the state’s borders.

The legislation – and S&P’s role in the legislative process – helped discourage other states from adopting laws that would get tough on Wall Street banks and investors, according to Kathleen Engle, a law professor at Suffolk University Law School and co-author of a book on the mortgage meltdown, “The Subprime Virus.”

“S&P drew a line in the sand,” Engle said. “Once they won that battle and the Georgia legislature caved, other states were cowed and weren’t going to take on S&P.”

In Congressional testimony later in 2003, S&P’s Raiter denied that the company tried to influence legislation affecting the mortgage industry, saying that as “an independent and objective commentator on credit risk,” S&P generally didn’t take a position on questions of public policy.

While S&P supported efforts to combat predatory lending, Raiter testified, “It does not take a position on what legislative and regulatory actions would best accomplish that goal. Nevertheless, Standard & Poor’s has been closely following legislative and regulatory initiatives designed to combat predatory lending in order to determine how those laws might affect its ability to rate securities backed by residential mortgage loans.”

‘Race to the Bottom’

Engle counters that S&P’s stance as a neutral arbiter doesn’t wash; in reality, she said, the fees that it earned from Wall Street for rating mortgage-backed securities created an enormous conflict of interest.

A report released in April by the U.S. Senate Permanent Subcommittee on Investigations concluded that S&P and Moody’s engaged in a “race to the bottom,” providing favorable ratings on high-risk mortgage-backed securities in exchange for lucrative paydays from Wall Street.

“Credit rating agencies were paid by the Wall Street firms that sought their ratings and profited from the financial products being rated,” the report said. “The rating companies were dependent upon those Wall Street firms to bring them business and were vulnerable to threats that the firms would take their business elsewhere if they did not get the ratings they wanted. Rating standards weakened as each credit rating agency competed to provide the most favorable rating to win business and greater market share.”

The federal Financial Crisis Inquiry Commission concluded that “credit rating agencies were essential cogs in the wheel of financial destruction. The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly.”

Fabienne Alexis, an S&P spokeswoman, said the company has been “disappointed by the performance of our ratings” on mortgage-backed investments. “Our ratings were based on long-standing historical data and our transparent application of published ratings criteria,” she said. “We—along with financial institutions, regulators, other rating agencies, investors and homeowners—did not anticipate the extreme decline in the housing and mortgage markets. We profoundly regret that.”

For Barnes, the former Georgia governor, regrets aren’t enough. Too many people were hurt by the reckless practices of the investment banks and ratings firms, he said, and now Americans will be hurt again by S&P’s downgrade of the federal debt rating.

“I guess the government is not paying the rating agencies enough to rate its debt,” Barnes said. “If we’d just pay them a little bit more, maybe we’d get that AAA rating back.”

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