S&P Settles for $1.375 Billion Over Fraudulent AAA Ratings on Junk Mortgage Securities, While Moody's Pays $864 Million, Exposing 'Issuer-Pays' Conflict of Interest Model Where 73% of 2006 AAA-Rated Securities Were Downgraded to Junk by 2010

On February 3, 2015, the Department of Justice, 19 states, and the District of Columbia reached a $1.375 billion settlement with Standard & Poor’s (S&P) over allegations that the credit rating agency knowingly inflated ratings on risky mortgage-backed securities and collateralized debt obligations from 2004 to 2007, directly contributing to the 2008 financial crisis. The settlement was the largest penalty of its type ever paid by a credit rating agency and addressed S&P’s systematic practice of assigning AAA ratings—the highest possible grade indicating minimal default risk—to mortgage securities that were actually junk-grade investments backed by subprime loans to borrowers with poor credit and often fraudulent income documentation. The Justice Department’s investigation found that S&P executives knew they were issuing inflated ratings to maintain market share and fee revenue from Wall Street banks, with internal emails revealing that analysts understood they were creating a “monster” and building a “house of cards” that would eventually collapse. The settlement required S&P to pay $687.5 million to the federal government as a penalty and $687.5 million to states and the District of Columbia, but included no criminal charges against individual executives and no structural changes to the conflict-of-interest business model that had enabled the fraud.

The scale of rating agency failure was staggering and central to the financial crisis. The Financial Crisis Inquiry Commission estimated that by April 2010, 73% of all mortgage-backed securities that Moody’s had rated AAA in 2006—just four years earlier—had been downgraded to junk status. In 2007, as housing prices began to tumble, Moody’s downgraded 83% of the $869 billion in mortgage securities it had rated AAA in 2006, revealing that the vast majority of top-rated securities were actually high-risk investments that would suffer catastrophic losses. Between 2002 and 2007, an estimated $3.2 trillion in loans were made to homeowners with bad credit and undocumented incomes, bundled into mortgage-backed securities and collateralized debt obligations, and received high AAA or AA ratings from the major agencies despite being based on mortgages that had high default probability. These inflated ratings were not errors or misjudgments but systematic fraud driven by the agencies’ business model and their relationships with the Wall Street banks paying for ratings.

The credit rating agencies’ fraud was enabled by a fundamental conflict of interest in the “issuer-pays” business model, where rating agencies are paid by the financial institutions whose securities they rate rather than by investors who rely on the ratings. This structure, which emerged in the early 1970s when agencies abandoned the previous “investor-pays” model, created direct financial incentives for agencies to provide inflated ratings to keep issuers happy and prevent them from taking their business to competing rating agencies. Internal emails and documents revealed that S&P, Moody’s, and Fitch all understood this conflict. A 2006 email between colleagues at S&P stated: “Rating agencies continue to create an even bigger monster—the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.” Another S&P analyst wrote: “We rate every deal. It could be structured by cows and we would rate it.” These communications demonstrated that rating agency employees knew they were inflating ratings on junk securities but continued doing so because the business model rewarded market share and fee revenue over accuracy.

On December 3, 2008, shortly after the financial crisis reached its peak, the Securities and Exchange Commission approved measures to strengthen oversight of credit rating agencies following a ten-month investigation that found “significant weaknesses in ratings practices,” including conflicts of interest, inadequate staffing despite record profits, and flawed computer models. However, these regulatory reforms did nothing to address the fundamental “issuer-pays” conflict of interest or to hold individual executives accountable for the fraudulent ratings that had enabled the crisis. The Financial Crisis Inquiry Commission later concluded that agencies’ credit ratings were influenced by “flawed computer models, the pressure from financial firms that paid for the ratings, the relentless drive for market share, the lack of resources to do the job despite record profits, and the absence of meaningful public oversight.” This comprehensive indictment revealed that rating agency failures were not technical mistakes but systematic fraud driven by business incentives and enabled by regulatory capture.

In January 2017, nearly nine years after the financial crisis began, Moody’s agreed to pay $864 million to settle with the U.S. Department of Justice, 21 states, and the District of Columbia over allegations that it inflated ratings on risky mortgage-backed securities and collateralized debt obligations from 2004 to 2007. The settlement came years after S&P’s settlement and demonstrated the glacial pace of accountability for financial crisis fraud. Like the S&P settlement, Moody’s agreement included no criminal charges against individual executives, no admission of intentional fraud, and no requirement to fundamentally change the “issuer-pays” business model. The penalty represented a fraction of the profits Moody’s had earned during the housing bubble years and was treated as a cost of doing business rather than a deterrent to future fraud. Fitch Ratings, the third major rating agency that had engaged in identical practices, faced even less accountability, with minimal enforcement action despite participating in the same systematic inflation of ratings.

Despite overwhelming evidence of fraud—including internal emails showing knowledge that ratings were inflated, systematic patterns of downgrading securities shortly after issuance, and the statistical impossibility of 73% of AAA securities becoming junk within four years absent fraud—not a single credit rating agency executive faced criminal prosecution. The Justice Department pursued only civil settlements under the Financial Institutions Reform, Recovery, and Enforcement Act rather than criminal securities fraud or wire fraud charges that would have been applicable. This enforcement approach occurred during both the Obama and Trump administrations, demonstrating bipartisan regulatory capture and unwillingness to criminally prosecute financial executives. The executives who had overseen the fraudulent ratings practices during the housing bubble—including Moody’s CEO Raymond McDaniel and S&P President Kathleen Corbet—faced no personal criminal liability, professional sanctions, or requirement to disgorge compensation earned through fraud.

The rating agency settlements exposed how regulatory capture and the revolving door prevented meaningful accountability for financial crisis fraud. The SEC, which had designated S&P, Moody’s, and Fitch as Nationally Recognized Statistical Rating Organizations (NRSROs) and had embedded their ratings throughout financial regulations, had failed to provide meaningful oversight despite having statutory authority. The designation of NRSROs created a regulatory cartel where these three agencies enjoyed government-granted oligopoly power while facing minimal accountability. Congress had expanded the regulatory reliance on credit ratings through the 1975 regulatory framework, effectively mandating that banks, pension funds, and insurance companies use NRSRO ratings for capital requirements and investment decisions. This government mandate created captive demand for ratings and eliminated market discipline, as institutional investors were required to rely on ratings regardless of accuracy.

The modest financial penalties and absence of criminal charges demonstrated that credit rating agencies—like the banks whose securities they rated—operated under a “too big to fail” framework where their systemic importance shielded executives from criminal accountability. The Justice Department’s civil settlements included language about rating agencies’ critical role in financial markets and the need to avoid disrupting their operations, echoing the “collateral consequences” reasoning that Criminal Division Chief Lanny Breuer had articulated for not prosecuting major banks. This framework meant that the very institutions whose fraud had caused a systemic crisis were protected from truly consequential accountability because prosecuting them might harm the system they had corrupted. The circular logic revealed complete regulatory capture: rating agencies were systemically important because regulations required their ratings, yet this regulatory dependence meant they couldn’t be held meaningfully accountable for fraud without disrupting the regulatory framework.

The rating agency fraud and subsequent minimal accountability established a precedent that would enable continued corporate malfeasance in subsequent years. Despite the settlements and modest regulatory reforms under the Dodd-Frank Act, the fundamental “issuer-pays” conflict of interest remained intact, the same three agencies maintained their NRSRO oligopoly, and credit ratings remained embedded throughout financial regulations. The agencies faced no requirement to compensate investors who had relied on fraudulent ratings and suffered billions in losses. Pension funds, municipalities, and foreign banks that had purchased AAA-rated securities that proved to be junk received no restitution beyond the general settlements that went to government coffers rather than victims. The structure demonstrated that enforcement served political purposes—allowing the Justice Department to announce large penalty numbers—rather than achieving justice, deterring fraud, or compensating victims. The rating agency settlements, like the broader pattern of financial crisis accountability, established that corporations and executives could engage in massive fraud, cause systemic economic collapse, and face only modest civil penalties without criminal prosecution, personal liability, or fundamental business model changes.