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Wall Street turns its sights to Moody’s amidst S&P allegations

The US Justice Department’s decision to sue Standard & Poor’s has left investors pondering why Moody’s Investors Service and Fitch Ratings weren’t targeted for awarding the same top grades towards troubled mortgage bonds and other debt securities. “What purpose does it serve for the U.S. government to bring an action against S&P at this point in time? “At first glance, is this a bid for some sort of retribution for the company’s 2011 downgrade of the U.S.? Moody’s and Fitch assigned the same ratings to these transactions. Why aren’t they named as well?” wrote Bonnie Baha, the Head of Global developed credit at DoubleLine Capital LP, which oversees about $53 billion.

Indeed, the Financial Crisis Inquiry Commission and a Senate panel placed the blame squarely on S&P, Moody’s and Fitch for inflated ratings on mortgage-backed securities and collateralized debt obligations that facilitated the worst US financial crisis since the Great Depression. Together, the agencies have combined to provide nearly 96% of all ratings for governments and companies in the $42 trillion debt market in 2011. The U.S., in a lawsuit filed February 4 in federal court in Los Angeles, is alleging that the unit of New York-based McGraw-Hill Cos. defrauded investors by failing to adjust its analytical models or taking necessary steps to accurately reflect the risks of the securities because it was afraid of losing business.

Looking back, S&P lowered the U.S. government’s credit rating one step to AA+ from the top AAA rank on Aug. 5, 2011, after months of back and forth negotiations between President Barack Obama and Congressional Republicans over whether to raise the federal debt limit. Bond investors in particular repudiated the downgrade and U.S. borrowing costs fell to record lows as Treasuries rallied the most since 2008.

“It is true that debt markets have judged ratings company rankings to be unimportant”, Baha said. However, “my question is, why are U.S. taxpayers wasting money to prove a fact that’s already widely accepted in the market?” The Justice Department’s case “looks rather suspicious because Moody’s isn’t involved.” said Peter Wallison, co-director of the Washington-based American Enterprise Institute’s program on financial policy. “It’s very hard to see how Moody’s was doing anything differently than S&P,” he added yesterday.

Conversely, the S&P has not stood idle in its defense – Floyd Abrams, the Cahill Gordon & Reindel LLP lawyer representing the company, noted in a February 5 appearance on Bloomberg Television that investors required two ratings on CDOs before they would buy. “And yet we find ourselves now being accused of acting in bad faith, while everyone else acted in good faith, presumably.” He said on CNBC the same day that the Justice Department’s investigation intensified after the S&P downgrade, though he didn’t know if there was a direct link. “No one in the government has come to me and said, ‘That’s why we did it,’” Abrams said.

Ed Sweeney, an S&P spokesman, declined to elaborate on Abrams’s comments. Attorney General Eric Holder said February 5 in Washington that the complaint against S&P was seemingly unrelated to the downgrade. “There’s no connection between the two,” he said. “They did what they did, assessing what the creditworthiness was of this nation. We looked at the facts, the law and the investigation” and “made a determination that the filing of these lawsuits was appropriate.”

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