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The perils -- financial & constitutional -- of suing S&P

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By Peter Morici
Saturday, Feb. 9, 2013, 9:00 p.m.
 

The Justice Department is accusing Standard & Poor's of defrauding investors with optimistic ratings of mortgage-backed securities and derivatives prior to the financial crisis. While investors are entitled to answers about those conflicts, compensation and reforms, Attorney General Eric Holder and President Barack Obama, by singling out this bond rating agency over others, appear to be engaging in a political vendetta and are placing freedom of speech at risk.

In 2011, S&P, Moody's and Fitch were accused by a Senate committee of giving overly rosy ratings on mortgage-backed securities in the years prior to the financial meltdown of 2008 — and then contributing to the severity of the crisis by hastily downgrading hundreds of securities after the housing bubble burst.

Notably, S&P alone, in August 2011, downgraded U.S. government bonds — causing the president considerable embarrassment at a time when his re-election was far from certain. And this downgrade will raise U.S. borrowing costs (and ultimately curtail federal spending and Obama's progressive agenda) when the Federal Reserve deems it appropriate to end “quantitative easing,” which is artificially depressing all interest rates.

Often, federal prosecutors, when several firms have engaged in unsuitable practices, will single out one to obtain damages and reforms, then use that settlement to obtain concessions from the others; however, the singling out of Standard & Poor's certainly creates the appearance of sovereign and political abuse.

By any reasonable measure, U.S. debt and spending have reached unsustainable levels. Simply put, the tax increases necessary to bring the federal deficit down to a level that would stabilize the national debt as a percentage of GDP would certainly cause a deep recession — similar to conditions in Italy or Spain — and not yield the anticipated revenues. Hence, spending, in particular entitlement spending, must be cut. The president, however, has neither admitted this situation nor shown any inclination toward real entitlement reform.

By not downgrading U.S. debt, Moody's and Fitch have demonstrated the same neglect to investors that all three bond rating agencies practiced during the mid-2000s. Now, the Justice Department lets them pass by targeting S&P.

At the heart of the matter is the bond rating agencies' business practice of charging fees to the firms and state and local governments that issue bonds and financial houses that create derivatives. The resulting conflict of interest encourages overly rosy ratings that lag market assessments of company and government financial health.

The rating agencies have refused to change this business model; they find it too lucrative to put their public responsibility above profits. Thus, a legislative solution is required.

The bond rating agencies have clung to a First Amendment defense. But that has terrible public policy foundations. No individual may rely on free speech to knowingly deceive another for the purpose of financial gain. That is the textbook definition of fraud. And no reasonable assessment of the public or investor interests can justify that defense.

Yet, by singling out S&P — the firm that downgraded U.S. government debt — the attorney general and president have failed to acknowledge their own conflict of interest and create the appearance of retribution.

In other areas — for example, broadcast news coverage — the Obama administration has pressured networks it believes demonstrate a conservative bias. But it has kept its hands off those demonstrating similar preferences for its more liberal policies.

By suing S&P, and not Moody's and Fitch, Eric Holder and President Obama have failed to exhibit the sovereign restraint necessary to sustain the open and fair criticism of the government to sustain the American republic and, in the process, place constitutional protections at grave danger.

Peter Morici is a professor at the Smith School of Business at the University of Maryland and former chief economist at the U.S. International Trade Commission.

 

 
 


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