U.S. Suing S&P Smacks of Political Retribution

NEW YORK (TheStreet) -- The Justice Department is accusing Standard & Poor's of defrauding investors with optimistic ratings of mortgage-backed securities and derivatives prior to the financial crisis. While investors are entitled to answers about those conflicts, compensation and reforms, the attorney general and president, by singling S&P out of the field of bond raters, appear to be engaging in political vengeance and putting freedom of speech at risk.

In 2011, S&P, Moody's and Fitch were accused by a Senate Committee of giving overly rosy ratings on mortgage-backed securities in the years prior to the financial meltdown of 2008, and then contributing to the severity of the crisis by hastily downgrading hundreds of securities after the housing bubble burst.

Notably, S&P, alone, in August of 2011 downgraded U.S. government bonds -- causing the president considerable embarrassment at a time when his reelection was far from certain. This downgrade will raise U.S. borrowing costs, and ultimately curtail federal spending and the president's progressive agenda, when the Federal Reserve deems appropriate to end quantitative easing, which is artificially depressing all interest rates.

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Often, federal prosecutors, when several firms have engaged in unsuitable practices, will single out one to obtain damages and reforms, and then use that settlement to obtain concessions from the others; however, the selection of S&P certainly creates the appearance of sovereign and political abuse.

By any reasonable measure, U.S. debt and spending has reached an unsustainable level. Simply, the tax increases necessary to bring the federal deficit down to a level that would stabilize the national debt as a percentage of GDP, would certainly cause a deep recession, similar to conditions in Italy or Spain, and not yield the anticipated revenue. Hence, spending, in particular entitlement spending, must be cut; however, the president has neither admitted this situation nor shown any inclination toward real entitlement reform.

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By not downgrading U.S. debt, Moody's and Fitch, have demonstrated the same neglect to investors that all three bond rating agencies practiced during the mid-2000s -- now, the Justice Department lets them pass by targeting S&P.

At the heart of the matter is the bond-rating agencies' business practice of charging fees to the firms, state and local governments who issue bonds, and financial houses that create derivatives. The resulting conflict of interest encourages overly rosy ratings that lag market assessments of company and government financial health.

The rating agencies have refused to return to change this business model --they find the present too lucrative to put their public responsibility above profits -- and this requires a legislative solution.

The bond-rating agencies have clung to a First Amendment defense, but that has terrible public policy foundations. No individual may rely on free speech to knowingly deceive another for the purpose of financial gain -- that is the textbook definition of fraud -- and no reasonable assessment of the public or investor interests can justify that defense.

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Yet, by singling out S&P -- the firm that downgraded U.S. government debt -- the attorney general and president has failed to acknowledge their own conflict of interest and create the appearance of retribution.

By suing S&P, and not Moody's and Fitch, the attorney general and president have failed to exhibit the sovereign restraint necessary to sustain the open and fair criticism of the government to sustain American Democracy, and place constitutional protections at grave danger.

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This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Professor Peter Morici, of the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission. He is the author of 18 books and monographs and has published widely in leading public policy and business journals, including the Harvard Business Review and Foreign Policy. Morici has lectured and offered executive programs at more than 100 institutions, including Columbia University, the Harvard Business School and Oxford University. His views are frequently featured on CNN, CBS, BBC, FOX, ABC, CNBC, NPR, NPB and national broadcast networks around the world.