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Moody's to pay US$864m to settle subprime ratings claim

Moody's Investors Service agreed to pay almost US$864 million to resolve a multi-year US investigation into credit ratings on subprime mortgage securities, helping to clear the way for the firm to move beyond its crisis-era litigation.

[NEW YORK] Moody's Investors Service agreed to pay almost US$864 million to resolve a multi-year US investigation into credit ratings on subprime mortgage securities, helping to clear the way for the firm to move beyond its crisis-era litigation.

Moody's reached the agreement with the US Justice Department and 21 states, which accused the company of inflating ratings on mortgage securities that were at the centre of the 2008 financial crisis, the Justice Department said Friday in a statement.

That penalty is about a third of the US$2.5 billion that Moody's earned in the four years leading up to the crisis. Standard and Poor's settled similar claims with the US for US$1.5 billion last year.

"The agreement acknowledges the considerable measures Moody's has put in place to strengthen and promote the integrity, independence and quality of its credit ratings," the company said in an e-mailed statement. "As part of the resolution, Moody's has agreed to maintain, for the next five years, a number of existing compliance measures and to implement and maintain certain additional measures over the same period." Since the crisis, the bulk of government settlements have been shouldered by the biggest banks, which have paid more than US$162 billion in fines and penalties.

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Few executives on Wall Street have been individually charged or held personally responsible for misconduct.

Still, the settlement with Moody's helps the Obama administration move closer to wrapping up investigations of Wall Street firms for their actions leading up to the 2008 mortgage meltdown, a catastrophe that the Financial Crisis Inquiry Commission said wiped out US$11 trillion of American household wealth. The credit ratings industry has been the target of these investigations into Wall Street for years.

The Justice Department sued Barclays Plc in December for fraud over its sale of mortgage bonds after the bank balked at paying the amount the government sought in negotiations. The lawsuit is rare for big banks, which typically settle with the government rather than risk drawn-out litigation and a possible trial.

The next day, Deutsche Bank AG and Credit Suisse Group AG said they had agreed to pay a combined US$12.5 billion to resolve similar cases, though final settlements with the government haven't yet been announced.

Both Moody's Investors Service, a unit of Moody's Corp, and S&P played key roles in Wall Street's making of toxic, subprime mortgage bonds. While subprime home loans typically go to borrowers with the weakest credit, bonds backed by those mortgages received top-flight, AAA credit ratings. The bonds began coming apart in 2007 as the housing market collapsed, contributing to more than US$1.9 trillion in losses at financial firms worldwide during a crisis that almost collapsed the global banking system.

Investigators in Congress found after the crash that in some cases, credit rating firms were giving out top grades to junk deals simply to win business from the banks preparing the securities.  In 2007, Moody's said in public filings that it had ratings relationships with more than 11,000 corporate issuers, 26,000 public finance issuers, and that it had rated more than 110,000 structured finance securities, comprised primarily of mortgage bonds. As housing prices began to tumble that year, Moody's downgraded 83 per cent of the US$869 billion in mortgage bonds it had rated AAA in 2006."This crisis could not have happened without the rating agencies," the Financial Crisis Inquiry Commission concluded in 2011.

Today, Moody's remains the second-largest ratings company after S&P, and together with Fitch Ratings, these three bond graders still have over 96 per cent market share - a bigger hold than the government reported last year. In 2007, the triopoly graded 98.8 per cent of bonds outstanding, according to government data.

In troves of e-mails made public by Congress, S&P executives were caught criticising their own ratings. "We rate every deal. It could be structured by cows, and we would rate it," read one e-mail exchange between S&P executives. The Justice Department later included that exchange in its own lawsuit against S&P.

Whereas many outside observers viewed S&P's e-mails as severely damaging and an indictment in the public perception, few such e-mails from within Moody's have emerged. That stoked a broadly held view in the industry that the Justice Department could have a harder time proving misconduct of Moody's.

"We've known for years that conflicts of interest at credit-rating firms were a significant factor in causing the 2008 financial crisis," Sen Al Franken told Bloomberg when Moody's announced that it expected to be sued. "We can't let Wall Street be above the law," he said.

Mr Franken has proposed doing away with the rating industry's payment model, and in the writing of the 2010 Dodd-Frank Act targeted the way that bond issuers pay for their own debt to be assessed. The Securities and Exchange Commission, in its consideration of reform proposals, ultimately decided to keep the same business model for the industry in place. Since then, complaints have persisted that ratings shopping is alive and well in mortgage- and asset-backed bond markets.