It has come late, about five years late.
Nonetheless, the U.S. Department of Justice has finally taken action against one of the major actors in the global economic meltdown. Attorney General Eric Holder announced this week that the government filed a $5 billion civil suit against Standard & Poor's Ratings Services, one of the nation's largest credit rating agencies.
Federal prosecutors have accused S&P of fraud for knowingly misrepresenting the risk of mortgage-backed securities and other obscure financial instruments. Ratings agencies are paid fees by the companies that issue the securities they rate, an obvious conflict of interest, which prosecutors say led the agencies to downplay risks. In the years leading up to the global financial meltdown, S&P allegedly issued gold-plated ratings for highly questionable investments.
Investors, large and small, who relied on S&P's glowing assessments, lost billions of dollars when the housing market collapsed in 2008.
The federal lawsuit has particular relevance to California. It was filed in the Central District of California, centered in Los Angeles. The Central District was home to the now-defunct Western Corporate Federal Credit Union (WesCorp), formerly the nation's largest credit union. The federal government says WesCorp collapsed in large part because it relied on S&P's inflated ratings of mortgage-backed securities.
California Attorney General Kamala Harris is one of 16 state attorneys general who have joined federal prosecutors in the lawsuit. Harris blames S&P for losses of $1.36 billion sustained by the state's largest pension funds, the California Public Employees' Retirement System and the California State Teachers' Retirement System.
CalPERS filed its own lawsuit in 2009 against S&P and two other ratings agencies, accusing S&P of providing "wildly inflated and unreasonably high" AAA ratings to a string of investment deals that went bad.
The impact of inflated ratings on the lives of individuals cannot be understated. It cost jobs, and led to business failures and foreclosures, disrupting the lives of millions of people, and helped precipitate the worst recession since the Great Depression, a recession from which the nation has yet to recover.
In its defense, S&P says its "analysts worked diligently to keep up with an unprecedented, rapidly changing and increasingly volatile environment . Regrettably, the breadth, depth and effect of what ultimately occurred were greater than we and virtually anyone else predicted."
Emails and other documents that the government has made public suggest that S&P knew far more about the risks than its published ratings stated, but chose not to downgrade its ratings for fear of losing clients.
The lawsuit is late in coming, five years after the housing bubble burst. The Obama administration should have taken action much earlier, but went gentle on Wall Street for its first two years in office.
Even at this late date, the lawsuit is worth pursuing, though federal action shouldn't end there. Congress needs to remove the perverse incentives that exist when ratings agencies grading an investment are paid by the entities trying to sell that same investment.