THE BLOG
02/07/2013 10:42 am ET Updated Apr 09, 2013

Downgraded: Why S&P Should Admit its Mistake

As someone not on the payroll of Standard & Poor's, I was overjoyed when I heard about the Justice Department's long-overdue lawsuit against the ratings agency for its part in creating the subprime mortgage crisis.

First, let's start at the top. What S&P (as well as the other big ratings giants Moody's and Fitch) essentially did was put its gold stamp of approval on junk. That part remains uncontested.

What is still in doubt is whether it did it deliberately or at least negligently. But forgetting the legal aspect for a second and speaking as a banker, I just don't see how in the world this highly regarded and professional firm could not have known what it was doing, given the overt risks inherent in subprime mortgages.

That brings us to the second important point, which is the first amendment defense likely to be mounted by S&P in court. In a nutshell, the company will claim that their ratings are really opinions that are protected under the freedom of speech clause of our Constitution. Great argument except that two federal judges have already ruled that S&P's reports are distributed to select private parties only and, as such, are not "matters of public concern" or shielded by the first amendment.

S&P, of course, will argue that its opinions are part of the public discourse, and on this point, I agree with them completely.

I think that S&P's opinions are very much a matter of public concern; after all, the impact of those "opinions" was to encourage large-scale investment in mortgage bonds that eventually turned out to be worthless, bankrupted major banks, nearly destroyed our economy, stalled our growth, generated large-scale unemployment, and put us into the deepest recession in American history since the Great Depression! If there is anything that impacts the public more than that, I don't know what it is.

But if S&P's ratings really are public in nature, then what the company allegedly did is tantamount to a massive betrayal of America. If a president did that, he would be impeached. If a military general did that, he would be tried for treason. Then why should a ratings agency not have to pay a severe fine for its infractions? In fact, the first amendment defense could well be the company's biggest incompetence of all, for what it implies is much worse than anything it could admit to.

What S&P should do instead is admit its mistake -- come clean about how it got caught up in the circus of greed and irresponsibility before 2008 and take its lumps like a world class company. Only then, once it has made sincere amends to the country for its deplorable actions, can it lift itself up from the muck it sank into, and regain its honor.

A ratings agency's opinions are not highly prized (and expensively priced) just for the analysis behind them but because of the reputation of the company that puts its name on the ratings. That name, S&P, was synonymous with reliability and honesty until the subprime debacle, and if the company wants to continue to trade on its credibility, it sorely needs to earn back the trust of the American public. The only way that will happen is if it owns up to what it did, for anything less would be an insult to us after the pain that we suffered as a result.

SANJAY SANGHOEE has worked at leading investment banks Lazard Freres and Dresdner Kleinwort Wasserstein as well as at a multi-billion dollar hedge fund. He has an MBA from Columbia Business School and is the author of a thriller entitled "Merger" (St. Martin's Press) that Chicago Tribune called "Timely, Gripping, and Original". Please visit www.sanghoee.com for details.