What message to Wall Street from US lawsuit against Standard & Poor's?

The Justice Department's civil lawsuit against the credit-rating agency Standard & Poor's aims to assign responsibility for the recent financial crisis. But expectations that Wall Street will change its ways are mixed.

With its civil lawsuit against credit rating agency Standard & Poor’s, the US Justice Department is embarking on one of the most aggressive efforts yet to hold Wall Street accountable for the financial crisis.

As the government's first crackdown on a rating agency, the suit, filed late Monday in federal court in Los Angeles, marks a watershed moment in the investigation into the financial meltdown. It’s a bold move that the government is hoping will send a stern warning to Wall Street – and has already sent a jolt through the stock market – but one that some analysts predict will do little to change “business as usual.”

The Justice Department's lawsuit claims that S&P “knowingly, and with intent to defraud ... executed a scheme to defraud investors” by giving triple-A ratings to shoddy mortgage-backed securities that led to one of the worst financial crises since the Great Depression.

“The failures of credit rating agencies were essential cogs in the wheel of financial destruction," the Financial Crisis Inquiry Commission wrote in its final report, in 2011. “This crisis could not have happened without the rating agencies.”

S&P has acknowledged that its ratings were wrong, but insists it did not knowingly issue triple-A ratings to junk securities at a time when few on Wall Street or in the government saw the dangers posed by subprime lending. The DOJ suit "would be entirely without factual or legal merit," said S&P, in a statement.

"Regrettably, the breadth, depth, and effect of what ultimately occurred were greater than we – and virtually everyone else – predicted," the statement said.

And because it alone was singled out among other rating agencies that awarded sterling ratings to mortgage-backed securities, including Moody’s Corp. and Fitch Ratings, S&P has suggested the DOJ is retaliating for S&P’s downgrade of the US credit rating in 2011.

Nonetheless, the suit marks an aggressive new tack by the federal government.  

“Part of what’s going on is closure about the financial crisis,” says Jeffrey Manns, associate professor at George Washington University Law School in Washington.

Indeed, the suit is the government’s attempt to hold Wall Street accountable for wrongdoing that led to the financial crisis, something the current administration has been accused of failing to do.

But will the DOJ’s civil suit amount to more than mere finger-pointing or a slap on the wrist? Will Wall Street take notice?

“It could have a very significant effect on Wall Street,” says Mr. Manns. “The government is taking a more aggressive posture in seeking accountability, so it’s certainly a warning to rating agencies and Wall Street as a whole that the government is going to hold actors accountable for wrongdoing.”

In fact, the market has already reacted sharply to the government’s suit. After news of the suit spread, McGraw-Hill, parent company of S&P, saw its stock tumble to levels not seen in 25 years. It plunged 13.8 percent Monday, the most it has fallen since the stock market crash in October 1987. Moody’s, the second-largest rating agency, also fell 10.7 percent.

The best-case scenario is that “the investigation will help ensure greater responsibility in ratings,” says Michael Greenberger, a professor at the University of Maryland School of Law in Baltimore and a former federal financial regulator who supports the lawsuit. The big lesson learned, he adds, is that “abuses [by rating agencies] were so great there will be less inclination to be dazzled by ratings themselves.”

That, of course, is the best-case scenario. Some analysts expect little, if any, change on Wall Street as a result of the suit.

“Very little has changed in the culture of Wall Street ... and I expect little to change as a result of the pending suit,” says Timothy Canova, professor of law and public finance at Nova Southeastern University in Fort Lauderdale, Fla. “As long as these cases brought by the DOJ are civil claims settled out of court, it won’t be seen as much other than the cost of doing business. Not until criminal cases are brought against top executives on Wall Street [will things change].”

Adds Mr. Greenberger, “Fine these people all you want – it’s tantamount to you or I paying a traffic ticket. The only thing appropriate here is jail time.”