The Strategist

Moody`s to pay $ 864 million for inflated mortgage ratings

01/16/2017 - 15:08

The US Department of Justice and rating agency Moody`s said they reached an agreement in legal dispute. The agency will pay $ 864 million of compensation to the American authorities for incorrect assignment of rating to mortgage-backed securities in anticipation of the mortgage crisis in 2007. Inflated ratings of mortgage-backed securities were one of the main causes of the mortgage crisis, resulted in the global financial crisis in 2008-2009.

"On the eve of the financial crisis Moody`s has failed to comply with its own credit ratings standards and failed in regard to commitment to the principle of transparency, - noted Deputy Minister of Justice Bill Baer in a statement. - Today's agreement includes not only fines and de facto recognition these facts, but also promise of Moody`s to take new measures that will contribute to reliable performance ratings."

The financial crisis has partly been caused by a practice of overpricing of securities ratings, issued by the world’s major banks and mortgage companies and provided with high-risk (subprime) mortgages on US residential real estate. In 2006-2007, many borrowers, mainly low-income US citizens, found themselves unable to afford mortgage payments, which led to an increase in defaults, alienation of housing and falling prices. Securities backed by such mortgages also began to fall in price, although earlier they had been highly rated by leading rating agencies. Collapse of the mortgage market led to a crisis in US financial markets, losses for the major banks and, as a consequence, liquidity crisis in the form of borrowed funds provided by banks. In turn, the liquidity crisis has led to the global financial crisis in 2008-2009.

Already during the crisis, many experts and journalists accused credit rating agencies, financial companies and banks of conflicts of interest. Among other things, rewards of agencies depend on commissions received for assigning ratings. Thus, assignment of low ratings to high-risk securities threatened the agencies with loss of customers - issuing banks. Back in 2009-2010, public criticism made leading rating agencies change their rules and activities in order to tighten control over the rating independence. Yet, investigation concerning the agencies went on. The agreement with Moody`s was a result of one of the largest of such investigations. "Our investigation has revealed, and Moody` s agrees with this, that the agency used less stringent standards than those which the agency itself has publicly stated - said Benjamin C. Mizer, Principal Deputy Assistant. - Investors relied on the agency’s credit ratings, which were believed to be objective and independent, so that investors expected Moody`s to follow its own standards." Size of a penalty to be paid to the federal government will amount to $ 437.5 million. The remaining funds will be distributed between 21 states conducted their own investigation and the District of Columbia.

In turn, Moody`s itself stated: "After careful consideration, we decided that the agreement significantly reduces risks and costs of further proceedings, which serves interests of our company and its shareholders. Moody`s continues to hold the opinion about reliability of existing rating systems and methodologies for their determination, and notes that this agreement does not contain any findings of violations of laws and recognition of guilt."