Five years after the mortgage crisis sent the U.S. economy into a tailspin, the U.S. government is suing Standard & Poor’s, a division of McGraw-Hill (NYSE:MHP), over the ratings it gave to mortgage backed securities.
Shares McGraw-Hill tumbled about 6% in Tuesday morning trading, while shares of Moody’s (NYSE:MCO), the parent of credit rating rival Moody’s Investor Service, dropped almost 3%.
On Monday, the government sued S&P for fraud in U.S. District Court in Los Angeles, alleging that S&P continued to give favorable credit ratings to mortgage backed securities until 2007, despite knowing that failure rates for subprime mortgages were skyrocketing as early as 2006, the Associated Press noted.
Investors relied on the ratings given by S&P and other credit rating firms when purchasing mortgage-backed securities. When the mortgage market collapsed, those securities tumbled in value, leaving many investors, including major institutional investors, with hefty losses.
The government argues that competition between the credit ratings agencies led them to offer higher rating for securities in order to generate more business from securities-issuers. In order to get the most business, S&P ignored rising credit risks and applied high credit ratings to securities that did not deserve them.
In its lawsuit against S&P, the government is seeking only financial penalties, not criminal charges. S&P has denied any wrongdoing.