The Breakdown

Explaining Southern California's economy

Justice Department v. Standard & Poor's: Is revenge a motive?

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That's what Matt Nesto and Jeff Macke at Yahoo Finance think, and you can watch them talk about it here.

The timing of the Justice Department's lawsuit against the credit rating agency — alleging that S&P fradulently overrated numerous mortgage-backed securites in the lead-up to the financial crisis — is a tad suspicious, surfacing as Washington is about to enter what could be a fractious debate over sequestration

Those automatic cuts could begin March 1 if Congress doesn't resolve or delay them. And hanging over the process, like Damocles' sword, is the threat that S&P in particular will downgrade U.S. debt again,  repeating an action that it took after the debt ceiling debate in 2011.

The Justice Department filed its 124-page complaint — which contains enough securities-market abbreviations (RMBS, CDO, SVP...) to thrill even the most jaded of finance geeks — in Los Angeles late Monday. Various reports suggest that state attorneys general will follow suit, with California's Kamala Harris and New York's Eric Schneiderman leading the charge. 

UPDATE: As expected, California filed suit on Tuesday. This is from the LATimes:

The barrage of state and federal actions signal an aggressive new push against one of the mortgage crisis’ key actors. The California action is the first use of its False Claims Act by Harris to pursue a major player in the mortgage meltdown. Harris in 2011 created a mortgage fraud strike force to pursue investigations related to the housing crisis and said she would use her powers under the act to pursue securities cases.

Under the state law, which makes it a crime to defraud the state, damages of up to three times the amount of the claim can be awarded if the victim was an institutional investor, such as one of the state's pension funds. In particular, the California Public Employees' Retirement System and the California State Teachers' Retirement System invested heavily in mortgage-backed securities and other financial instruments rated by S&P during the boom years.

[And why were CalPERS and CalSTRS making those investments? Because the return on mortgage-backed securities was good, and both pension funds have unforgivinging return targets that they need to meet each year.]

California was the chosen venue because of the sheer magnitude of the damage the housing downturn inflicted here. Potential jurors on the case — a civil rather than a criminal trial — would likely have at least some exposure to the pain the meltdown caused.

A big question has arisen already: Why is the Justice Department singling out S&P, years after the fact, while not going after Moody's and Fitch Ratings, the other two big rating agencies that  assigned ratings to securities during the housing boom? Neither has downgraded the U.S.A. That doesn't mean they won't. But even if both did, they'd still be one downgrade behind S&P, if that agency lowers its U.S. debt rating for the second time.

For its part, S&P said that it just did what the other agencies were doing before the housing collapse — and that none of them understood how much risk was building up in the subprime part of the market, because they'd never seen that market grow at such a rapid pace.

So is the Justice Department pursuing...justice, long overdue? Or is revenge a dish best served cold in sunny L.A.?

Take it to the comments if you have any ideas, and in the meantime, I'll curl up with the complaint and see if I can find anything juicy in there.

(And for what it's worth, the Justice Department filed its complaint in a city that fired S&P in 2011.)

Follow Matthew DeBord and the DeBord Report on Twitter. And ask Matt questions at Quora.

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