FRAUD CASE: Iowa Part Of Suit Over Subprime Ratings

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NEW YORK (CNNMoney) — The Justice Department and several states, including Iowa, have filed a lawsuit against Standard & Poor’s, bringing renewed focus to the inaccurate ratings of subprime mortgage securities that helped trigger the financial crisis.

The suit charges S&P with giving deceptive ratings to the mortgage securities that greatly underestimated the risk to investors. It did so, according to the suit, in order to collect fees from the firms that were pooling the risky home loans into securities.

The alleged misdeeds occurred from 2004 through 2007, the period typically referred to as the housing bubble. The decline in the housing market preceded a meltdown in financial markets and was a key factor in what was known as the Great Recession.

S&P could be on the hook for massive damages. Attorney General Eric Holder said Tuesday that the government had identified more than $5 billion in losses from collateralized debt obligations — mortgage-related investments typically referred to as CDOs — rated by S&P between March and October of 2007.

“During this period, nearly every single mortgage-backed CDO that was rated by S&P not only underperformed — but failed,” Holder said. “Put simply, this alleged conduct is egregious — and it goes to the very heart of the recent financial crisis.”

Holder was joined at a press conference Tuesday by attorneys general from six states, including Iowa, and the District of Columbia who are pursuing similar civil suits against S&P.

“We allege that S&P misled investors and market participants, which includes Iowa consumers,” said Iowa Attorney General Tom Miller. “Th company falsely promised that its investment analyses were independent and objective. People relied on these representations to make important financial decisions.”

In a statement Monday, S&P called the lawsuit “entirely without factual or legal merit.” The firm said that it “deeply regrets” that its ratings “failed to fully anticipate the rapidly deteriorating conditions in the U.S. mortgage market,” but that it relied on the same data as U.S. government officials and other analysts who failed to predict the housing bust.

S&P is a division of McGraw-Hill, whose shares dropped 7% in Tuesday trading, after tumbling 13.8% Monday following early reports of the suit. Shares of fellow ratings agency Moody’s also were lower Tuesday after a plunge late Monday.

A Moody’s spokesman declined to comment when contacted Monday. A spokesman for Fitch, the other of the three big ratings agencies, said Monday the firm has “no reason to believe Fitch is a target of any such action.”

Analysts have long pointed to ratings agencies as key culprits in the financial crisis.

Wall Street firms and other investors rely on the agencies to analyze risk and give debt a “grade” that reflects the borrower’s ability to pay the underlying loans. The safest investments are rated “AAA.”

Some investors, including pension funds and insurance companies, operate under guidelines that require them to hold a certain percentage of highly rated securities in their portfolios.

In the years preceding the meltdown of 2008, large numbers of securities received AAA ratings, even though they were backed by risky mortgages.

Those mortgage-backed securities paid investors well while housing prices were going up and borrowers could sell their homes at a profit. But as the housing bubble collapsed, foreclosures soared. Critics say that because the major ratings agencies are paid by banks and other issuers of securities rather than investors, they succumbed to a conflict of interest in giving their seal of approval to dubious investments.

“Credit rating agencies allowed Wall Street to impact their analysis, their independence and their reputation for reliability,” Sen. Carl Levin, a Michigan Democrat, said in a 2010 hearing. “And they did it for the money.”

A 2011 Senate report on the financial crisis said the agencies “weakened their standards as each competed to provide the most favorable rating to win business and greater market share.”