It is all but certain that ratings of mortgage-backed securities by S&P and Moody's (MCO) were influenced by the money that the issuers paid to the credit ratings agencies. This money was not for bribes, but it did fatten the wallets of the two operations. Congress has been all over the agencies to improve their practices and make them more transparent. Several government agencies have stated that the firms should be regulated.
In addition to government concerns, some investors are in the process of suing Moody's and S&P over whether their ratings of certain securities were so wildly off base that it cost many funds that put money into derivatives billions of dollars.
The controversy about ratings was becoming a little less fractious until recently, when S&P reversed an important ratings downgrade. According to The Wall Street Journal, "In a reversal in its evaluation of a clutch of mortgage bonds backed by commercial property, Standard & Poor's on Tuesday raised the ratings on several securities it had downgraded a week ago." The paper reported that it is still unclear why the ratings were changed, but the action will certainly cause Congress to take a closer look at the practices at S&P and Moody's.
Can the ratings agencies make and change their opinions about the value of investment vehicles at will and without any regulation? A novel defense of the practice is being mounted by a legal team headed by noted First Amendment lawyer Floyd Abrams. His contention will be that the agency ratings are "free speech" and therefore protected by the Constitution. That sounds intriguing, but it is not likely to prevail as a defense. The government views the agencies as firms that operate with deep conflicts. That is almost certainly right -- and regulation is just around the corner.
Douglas A. McIntyre is an editor at 24/7 Wall St.