I found two pieces on the federal government’s suit of S&P particularly interesting because both make important points I hadn’t thought of.

First, the Wall Street Journal‘s editorial page take, which is titled “Payback for a Downgrade?” It’s dec line is: The feds sue S&P but not Moody’s for pre-crisis credit ratings. The Journal editors speculate that the reason the U.S. government singled out S&P and didn’t go after Moody’s is that S&P, not Moody’s, downgraded government debt in 2011. Excerpt:

Meanwhile, a McClatchy Newspapers report says that it was around that time that Moody’s, which did not downgrade the government, was dropped from the federal investigation. Ask any investor and he’ll likely tell you that Moody’s was equally awful in forecasting the mortgage debacle.

The Journal also points out the absurdity of suing a company for fraudulent products when that same government continues to force people to buy its products:

And to this day, more than two years after the Dodd-Frank law ordered their repeal, SEC rules still force institutions to follow the advice of these government-anointed credit raters. Therefore the more appropriate defendant for Monday’s lawsuit would be the SEC. But as a modest first step before suing a company for $5 billion, shouldn’t the government at least stop mandating its products?

Also, there’s a freedom of speech/press issue here. Notice that S&P’s attorney is the noted defender of the First Amendment, Floyd Abrams.

The second is by Marc Joffe, a former employee of Moody’s. It’s titled “The S&P Lawsuit: Can It Fix the Rating System?” Joffe raises two other possible reasons for the U.S. government singling out S&P, both of which he finds more plausible:

Two other options seem more likely: (1) the other two agencies may still be in settlement talks with DOJ [Department of Justice], or (2) DOJ has a better case against S&P.

Joffe highlights one part of the DOJ complaint that helps make his case for (2) above:

According to the complaint, S&P management instructed employees not to publish software and data updates that would have resulted in lower ratings. For example, pages 42-48 of the complaint detail how S&P management suppressed an update to the agency’s LEVELS tool that relied on a much larger and more representative set of mortgages.

For some time now, Marc Joffe has been trying to figure out how to make the rating system better. Here’s his terse summary of the current system of ratings:

Given the importance of ratings, we need alternatives to the way they are now produced, i.e. by for profit companies with known conflicts of interest using proprietary data and analytics together with closed door rating committee meetings.

And here’s his alternative:

A much better alternative would be a system based on open source rating software, with fully transparent inputs and outputs, and no rating committee discretion. This fully open, fully deterministic approach controls biases regardless of whether the analysis is funded by investors, issuers, foundations or governments. It also allows a distributed peer review process to occur over the internet. An excellent case for open source ratings appeared recently on Naked Capitalism. PF2 has advanced this idea by supporting my Public Sector Credit Framework – a simulation tool for rating government bonds