McGraw-Hill Cos. tumbled the most in 25 years as the parent of Standard & Poor’s said it expects to be sued by the U.S. over inflated mortgage-bond rankings that helped ignite the worst financial crisis since the Great Depression.
McGraw-Hill fell 13.8 percent to $50.30 in New York trading, the most since the stock market crash in October 1987. The Justice Department and state prosecutors may file lawsuits this week against the largest ratings firm over its grades of certain collateralized debt obligations bundled during the housing boom, two people familiar with the matter said.
Ratings firms have faced criticism from U.S. lawmakers over how they granted top grades to securities that packaged home loans from the riskiest borrowers, leading to a credit seizure that sent the world’s largest economy into its longest recession since 1933 as defaults soared and values plummeted. The Justice Department will sue under a statute enacted in 1989 to stabilize and reform the savings and loan industry, S&P said.
“It’s a new use of this statute,” Claire Hill, a law professor at the University of Minnesota who has written about the ratings firms, said in a telephone interview yesterday from Minneapolis. “This is not a line to my knowledge that has been taken before.”
S&P described the Justice Department strategy based on the S&L statute as “questionable,” saying in a statement it’s “an attempt to end run well-established legal precedent.”
A Justice Department lawsuit “would be entirely without factual or legal merit,” S&P said. “It would disregard the central facts that S&P reviewed the same subprime mortgage data as the rest of the market -- including U.S. Government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained -- and that every CDO that DOJ has cited to us also independently received the same rating from another rating agency.”
Adora Andy, a spokeswoman for the Justice Department, declined to comment.
Analysts at New York-based S&P, Moody’s Investors Service and Fitch Ratings, majority-owned by Fimalac SA of Paris, were pressured to give their stamp of approval to complex investments in a “race to the bottom” to win lucrative business from Wall Street banks, the U.S. Senate Permanent Subcommittee on Investigations said in an April 2011 report.
Banks create collateralized debt obligations by bundling bonds or loans into securities of varying risk and return. They pay ratings firms for the grades, which investors may use to meet regulatory requirements.
Moody’s Corp., owner of the second-largest ratings provider, fell 10.7 percent yesterday to $49.45.
The credit-grading business was targeted by lawmakers in the 2010 Dodd-Frank Act after the collapse of top-ranked mortgage-backed securities contributed to $2.1 trillion in losses at the world’s largest banks. Reports from the Senate panel, along with the Financial Crisis Inquiry Commission, cited failures of the companies as a reason for the financial crisis.
“Credit rating agencies erroneously rated mortgage-backed securities and their derivatives as safe investments,” the Financial Crisis Inquiry Commission said in its 2011 report.
While the 18-month recession ended in June 2009, with the global economy contracting 2.4 percent that year, the U.S. has yet to recover 3.23 million of the 8.74 million jobs that were lost. The unemployment rate last month was 7.9 percent, compared with 5 percent in January 2008.
S&P, in its statement yesterday, cited court rulings that have dismissed challenges to the opinions of ratings firms. The company also said it planned to fight any lawsuits.
“If DOJ does bring suit, we will vigorously defend our Company against such meritless litigation,” the company said.
Attorneys general from at least two U.S. states have filed claims against S&P challenging its method of rating mortgage- backed securities.
Illinois Attorney General Lisa Madigan accused the ratings firm of putting profitability before accuracy.
“S&P ignored the increasing risks posed by mortgage-backed securities, instead giving the investment pools ratings that were favorable to its investment bank client base,” Madigan said in a January 2012 statement announcing the filing.
In a Nov. 7 decision, Cook County, Illinois, Circuit Court Judge Mary Anne Mason rejected defense arguments that ratings firms’ opinions were protected by constitutional guarantees of free speech. A status conference is scheduled for March 26.
In 2009, then-Ohio Attorney General Richard Cordray sued S&P, Moody’s and Fitch at the U.S. court in Columbus, accusing the firms of issuing faulty ratings that caused five public employee pension funds on whose behalf he sued to buy money- losing investments.
U.S. District Judge James L. Graham threw out the case in September 2011, ruling the ratings were “predictive opinions,” and that absent specific allegations of intent to defraud, the firms could not be held liable.
A Cincinnati-based federal appeals court unanimously upheld that decision in December.
Cordray was appointed by President Barack Obama in January 2012 as director of the federal Consumer Financial Protection Bureau in Washington.
In November, an Australian judge ruled S&P misled investors by giving its highest credit grade to securities whose value plunged during the global financial crisis.
S&P was “misleading and deceptive” in its rating of two structured debt issues in 2006, Federal Court Justice Jayne Jagot said in her ruling released Nov. 5 in Sydney.
Copyright 2014 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.