US sues Standard & Poor's over its ratings of bundled mortgages

The U.S. government has filed a civil fraud suit against Standard & Poor’s that claims the ratings service gave unwarranted optimistic ratings to bundled mortgages that tanked during the financial downturn.

The Justice Department filed suit in Los Angeles federal court on Monday, report Reuters, the New York Times DealBook blog and the Wall Street Journal (sub. req.).

DealBook says the suit “is the first significant federal action against the ratings industry, which during the boom years reaped record profits as it bestowed gilt-edged ratings on complex bundles of home loans that quickly went sour. The high ratings made many investments appear safer than they actually were, and are now seen as having contributed to a crisis that brought the financial system and the broader economy to its knees.”

The suit focuses on S&P’s ratings of collateralized debt obligations and residential mortgage-backed securities. According to the DOJ, conflicts are created because of the ratings service’s financial model—in which the bond issuer pays for the ratings.

“As S&P knew, contrary to its representations to the public, S&P’s desire for increased revenue and market share in the RMBS and CDO ratings markets, and its resulting desire to maintain and enhance its relationships with issuers that drove its ratings business, improperly influenced S&P to downplay and disregard the true extent of the credit risks,” the suit says.

S&P said in a statement in advance of the filing that “a DOJ lawsuit would be entirely without factual or legal merit.” The company says it has spent $400 million to improve the quality of its ratings.

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