Since the Justice Department sued S&P for fraud in February, the
media has been awash with concerns as to whether a lawsuit against Moody's will
inevitably follow - and questions about the lack of a lawsuit against Moody's
pointing to the potential for bias on the side of the DOJ. The inference drawn was that the DOJ might be
targeting S&P because S&P downgraded the debt of the United States.
Meanwhile, market participants and researchers have honed
in on the fact that other credit rating agencies issued “virtually identical”
grades on the same securities that lie at the heart of the lawsuit.
Commenting on the fact that S&P alone has been sued
(at this stage) by the DOJ, a member of S&P's general counsel reportedly remarked “The
S&P ratings for the CDOs at issue in this lawsuit are identical to the
ratings issued by other rating agencies. So we don’t have an explanation and
you’ll have to ask the Department of Justice…”
Meanwhile, Edwin Groshans, a managing director, at Washington-based equity research firm Height Analytics LLC, reportedly commented that “Given that the ratings between S&P and Moody’s were identical, a loss by S&P would create significant uncertainty for Moody’s regarding whether the Department of Justice would take action against it also…”
Of course, while these arguments may have been carefully considered, and may even have some rational basis, they are built on a faulty premise. Let us explain why.
Straw Man Argument
The key distinction is that the DOJ is not suing for fraud in
the rating provided. The DOJ isn't
saying the rating was wrong or imprecise or otherwise lacking in predictive
content. Therefore, that Moody's provided the same or an equivalent rating has
no import.
The DOJ is saying that in the context of these
securities, it is concerned that S&P maneuvered its ratings process, in a
manner neither objective nor unbiased, to achieve a necessary result (including
the generation or maintenance of revenues).
As such, if Moody's already had achieved THAT result based on its
then-current methodology, it would not have had to maneuver towards it. No foul committed.
In the case of active ratings competition, it is often
(but not always) the case that any jockeying done is done (or needs to be done)
by the more severe rating agency/agencies, so as to allow them to compete with
other raters who have a rosier view.
An Example
Suppose we have a world with only 3 rating agencies – Moody's,
Fitch and S&P – with two being selected to rate each bond. If for example Moody's and Fitch were the two
raters getting business because their methodologies resulted in the highest
rating, S&P alone would have an incentive to maneuver so as to win new
business or disrupt status quo. If they did, and their actions
resulted in their achieving the same view as say Moody's, then they may be
included on certain deals. But how does
this translate into any misdemeanor on the side of Moody's?
Is S&P is being subjected to
special attention, or targeted? We don't
know. But it has nothing whatever to do
with the nature of the lawsuit that, because Moody's may have rated the assets
at similar levels, it ought similarly to be accused of improper conduct.
That Moody's achieved a similar rating to S&P does not imply that its ratings process was influenced in a manner similar to that described by the DOJ in its lawsuit against S&P.
It may be the case that in certain scenarios all 3 rating
agencies simultaneously, knowingly, intentionally, lowered their ratings
standards to compete for the same business, while advertising themselves as
being independent investor services. This
is possible - but until that is known to have occurred, any argument suggesting
Moody's ought to be similarly defensive to any charges alleged of S&P is,
to us, simply an informal fallacy.
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