Accusing Moody’s Investors Service of withholding evidence documenting its role in the housing and financial crisis, Attorney General Edmund G. Brown Jr. announced a court action forcing the rating agency to explain why it gave its highest ratings to “risky and toxic” MBS.
Brown’s action comes seven months after the Attorney General subpoenaed Moody’s, although the firm has refused to comply with the subpoena.
“The need for court action to enforce a state subpoena is highly unusual,” Brown said, “because companies almost always comply without such a drastic step being necessary.”
However, he said that the agency has refused to explain its ratings practices to the state by saying that responding to the state subpoena would be a waste of time.
“The state’s subpoena seeks information regarding Moody’s decision to give its highest credit ratings to securities backed by risky and toxic mortgage-backed securities,” Brown said. “By taking this step, I intend to stop Moody’s from ignoring the state’s subpoena. The people of California have the right to know how this credit rating agency got it so wrong and whether it violated California law in the process.”
Moody’s as well as other credit rating agencies ignored red flags in the run-up to the deterioration in housing prices and gave stellar ratings to questionable securities, which made those investments seem as safe as government-issued Treasury bonds, Brown explained.
“But investors swiftly learned that the ratings were as worthless as the securities themselves,” he said.
Brown said Moody’s and other ratings agencies worked behind the scenes with the same Wall Street firms that created the securities, earning billions in revenue from those firms at a rate close to double what they earned for rating other securities.
“A central question in the aftermath of the financial meltdown is whether Moody’s gave investment banks and other securities packagers unwarranted high ratings at the expense of investors, who depended upon the integrity and independence of Moody’s ratings,” Brown said.
The subpoena that was issued by Brown’s office on Sept. 17, 2009, sought to find out whether the following facts are true:
- Whether the rating agency knew that the 'AAA' ratings it gave to high-risk securities were not warranted
- Whether the agency made fraudulent representations regarding the quality of its ratings
- Whether Moody’s made fraudulent representations concerning the independence of its ratings
- Whether it conspired with firms it rated to the detriment of investors
- Whether the rating agency profited from giving inaccurate ratings to some securities
- Whether it compromised its own standards and safeguards in order to increase its own profits.
A press release from the attorney general's office said that at the peak of the housing boom, these agencies gave their highest ratings to complicated, high-risk financial instruments that soon accelerated the financial collapse.
Brown said banks, pension funds and other investors, in California and elsewhere, relied on these ratings when they bought trillions of dollars of securities backed by risky mortgages, seeking high returns and reassured by ratings indicating the issues were low-risk. Those purchases helped inflate the housing bubble by allowing riskier mortgages.
The release further said that when the speculative bubble burst, those risky mortgages defaulted in record numbers and buyers were unable to sell these worthless securities. The agencies then downgraded the credit ratings of over $1.9 trillion in RMBS, an acknowledgement that they had ignored or did not understand the risks in the debt they rated, Brown said.
Brown’s investigation of the rating agency is one of many actions by his office to fight financial abuses relating to the mortgage meltdown, according to the press release.
Other actions include Brown's 2008 lawsuit that resulted in an $8.68 billion settlement with Countrywide Home Loans over its fraudulent lending practices as well as recent crackdowns by the Attorney General on foreclosure consultants and loan modification scammers.