When the housing market was on the road to nowhere in 2007, one ratings analyst found an unlikely muse: the post-punk band Talking Heads.
The analyst wrote a parody of the rock group's 1983 hit, "Burning Down the House," and emailed it to friends. His version of the song ended up in a 128-page lawsuit that the US Department of Justice has filed against rating agency Standard & Poor's.
According to the $US5 billion lawsuit, the unidentified S&P analyst, known in the complaint as "Analyst D," later sent a video of himself singing and dancing to his song while coworkers watched and laughed.
His version of the song begins:
Housing market went softer
Strong market is now much weaker
Subprime is boiling over
Bringing down the house."
Shortly after sending around the email, the analyst told his colleagues not to forward the song, but added: "If you are interested, I can sing it in your cube ;-)."
In his initial email, the analyst offered his apologies to David Byrne, the Talking Heads lead songwriter and front man.
For McGraw-Hill Companies, the parent company of the rating agency, the lawsuit is no laughing matter. The news that the government and several state attorney generals were going to sue S&P and McGraw-Hill over its alleged faulty rating of mortgage securities sent the company's stock down about 13.8 per cent on Monday.
The US government said that S&P's mortgage rating business was conflicted because it earned fees only when deals were sold, not if they were rejected.
The ratings agency was also not quick enough to update it models and analysis to reflect the fact that the US housing market was seriously weakening in early 2007, the government said.
"Considerations regarding fees, market share, profits, and relationships with issuers improperly influenced S&P's rating criteria and models," the government said in the civil complaint.
The government singled out about 30 collateralised debt obligations and other mortgage-backed securities that S&P rated in 2007, even as its own employees like Analyst D were noting the cracks in the foundation to the housing market.
It is not clear if federal prosecutors in Los Angeles plan to make the video of Analyst D available for public scrutiny.
Catherine Mathis, an S&P spokeswoman, called the video ‘‘obviously in poor taste.’’
‘‘While it may reflect a terrible sense of humour, it in no way reflects the hard work and analysis by the analysts rating securities,’’ Ms Mathis said.
'Structured by cows'
But there were more gems in the complaint filed in the Los Angeles federal court.
When two S&P analysts in April 2007 discussed the company’s model for collateralised debt obligations, one messaged that a deal was ‘‘ridiculous’’ and that S&P ‘‘should not be rating it’’, according to the filing.
‘‘We rate every deal,’’ the other replied, prosecutors said. ‘‘It could be structured by cows and we would rate it.’’
The US claims S&P, driven by a desire to increase revenue and market share, defrauded investors as it issued ratings on mortgage products while ignoring market risks. It rated more than $US2.8 trillion of residential mortgage-backed securities and about $US1.2 trillion of collateralised-debt obligations from September 2004 to October 2007, the government said.
A 2008 investigation into credit rating companies by the Securities and Exchange Commission found that that the firms improperly managed conflicts and weighed the risk of losing market share based on their ratings.
The report on Moody’s Investors Service, S&P and Fitch Ratings cited the discussion about the deal structured by ‘‘cows’’ and quoted an analyst who wrote in an email: ‘‘Let’s hope we are all wealthy and retired by the time this house of cards falters.’’
According to the US lawsuit, S&P in 2004 was considering a process for changing its rating criteria and reached out to investors and issuers of mortgage securities for their feedback. One executive questioned this practice, saying, ‘‘[W]e NEVER poll them as to content or acceptability!’’
Employees meanwhile were raising concerns about losing deals to competitors, according to the complaint. One analyst in May 2004 wrote that the company was losing a ‘‘huge’’ deal to a competitor because S&P was more conservative than others, the government said.
‘‘This is so significant that it could have an impact on future deals,’’ the analyst wrote, according to the complaint. ‘‘There’s no way we can get back on this one, but we need to address this now in preparation for future deals.’’
In 2007, one CDO analyst wrote to a former co-worker: ‘‘Does company care about deal volume or sound credit standards?’’
Emails and text messages can give prosecutors insight into the ‘‘unvarnished perspective’’ of company insiders and help them win trials because they’re easier for jurors to understand than more formal documents, said Robert Mintz, a partner at McCarter & English.
‘‘They tend to give jurors a flavor for the general atmosphere inside a company, and that in connection with other documents can often be quite damning,’’ said Mr Mintz, a former federal prosecutor in New Jersey.
S&P denies claims
S&P said in a statement that the government’s lawsuit is ‘‘meritless’’ and that at all times the company’s ratings ‘‘reflected our current best judgments’’ about mortgage securities and CDOs.
‘‘Unfortunately, S&P, like everyone else, did not predict the speed and severity of the coming crisis and how credit quality would ultimately be affected,’’ the company said.
The reference to a deal ‘‘structured by cows’’ had ‘‘nothing to do with RMBS or CDO ratings or any S&P model,’’ it said, contradicting the complaint. RMBS stands for residential mortgage-backed securities.
‘‘The e-mail excerpts cherry-picked by DOJ have been taken out of context, are contradicted by other evidence, and do not reflect our culture, integrity or how we do business,’’ it said.
Beginning in the fall of 2006 and continuing to about the spring of 2007, one executive regularly expressed frustration to colleagues that she was prevented by other executives from downgrading ratings of subprime mortgage securities because of concern that the company’s business would be affected, the government said.
‘‘This market is a wildly spinning top which is going to end badly,’’ said another executive in 2006, according to the complaint.