Brown Launches Investigation into Credit Rating Agencies' Role in Fueling Financial Crisis

Thursday, September 17, 2009
Contact: (916) 210-6000,

San Francisco – Launching an investigation into credit rating agencies’ role in fueling the financial crisis, Attorney General Edmund G. Brown Jr. today issued subpoenas to Standard & Poor’s, Moody’s and Fitch to determine whether the firms violated California law when they recklessly gave “stellar ratings to shaky assets.”

“Standard & Poor’s, Moody’s and Fitch put their seal of approval on high risk mortgage-backed securities, recklessly giving stellar ratings to shaky assets that proved toxic to the entire financial system,” Brown said. “This investigation is meant to determine how these agencies could get it so wrong and whether they violated California law in the process.”

Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings grade the creditworthiness of corporations and municipalities and the financial instruments (e.g., bonds and securities) they issue. Investors depend on these ratings to gauge risk and make investment decisions.

At the peak of the housing boom, these agencies gave their highest ratings to complicated financial instruments – including securities backed by subprime mortgages –making them appear as safe as government-issued Treasury bonds.

In rating these securities, the agencies worked behind the scenes with the same Wall Street firms that created them. For their work, the firms earned billions of dollars in revenue, at a rate nearly double what they earned for rating other financial products.

Banks, pension funds and other investors relied on these ratings when they purchased trillions of dollars of securities backed by subprime mortgages because of the high returns and apparent low-risk. Those purchases helped fuel the housing bubble by providing funding for lenders to issue ever-riskier subprime and other toxic mortgages. When the bubble burst, however, those risky mortgages defaulted in record numbers and investors were left holding worthless securities, unable to sell them.

Subsequently, the agencies downgraded the credit ratings of $1.9 trillion in residential mortgage backed securities, a tacit acknowledgement of their failure to adequately assess the risks of the debt they rated. The rating agencies either ignored or did not understand the risks of the debt they rated.

Given the role the rating agencies’ played, Brown is directing the agencies to provide by October 19, 2009 information that will help answer the following questions:

• Whether the rating agencies failed to conduct adequate due diligence in the rating process;
• Whether the rating agencies gave high ratings to particular securities when they knew or had reason to know that high ratings were not warranted;
• Whether the rating agencies failed to comply with their own codes of conduct in rating certain securities;
• Whether the rating agencies profited from giving inaccurate ratings to particular securities;
• Whether the rating agencies made fraudulent representations concerning the quality or independence of their ratings;
• Whether the rating agencies compromised their standards and safeguards for profits;
• Whether the rating agencies' statistical models captured the risk inherent in subprime and other risky assets and, if not, what was the rating agencies' response; and
• Whether the rating agencies conspired with the companies whose products they rated to the detriment of investors.

Brown’s investigation of the rating agencies is one of many actions by his office to address financial practices relating to the mortgage meltdown, including his 2008 lawsuit against Countrywide and recent crackdown on foreclosure consultants and loan modification scams.

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