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S&P probe could foster financial reform

The mortgage-bond market that David Tesher had described as “a wildly spinning top” was about to tumble when he convened a meeting at Standard & Poor’s Water Street headquarters in New York back in March 2007. Tesher, a managing director, told ratings analysts that Wall Street clients were under pressure to move souring mortgages into new securities called CDOs before the market crashed. Issuers needed the highest grades on the repackaged bonds to sell them to pension funds, banks and other investors.

“We’re in trouble because the rating companies determined where pension funds and others placed their money,” wrote Paul Kanjorski, a former Democratic Congressman from Pennsylvania. “Once Wall Street made decisions based on deal flow instead of honesty and real profits, it was a terrible thing.”

For decades, S&P and its chief counterpart, Moody’s Investors Service (MCO), benefited from the government’s blessing as arbiters of creditworthiness. Despite two attempts by Congress to rein in the raters and probes by a Senate committee and the Financial Crisis Inquiry Commission, this has not changed. Now, the world’s largest ratings firm stands accused of violating its own standards amid recent allegations that surfaced several weeks ago.

The Justice Department lawsuit, congressional records and interviews with former S&P employees seek to provide a blueprint that shows how the firm apparently mitigated internal dissent, misleading regulators and accommodating issuers at the expense of investors. The first government fraud case involving a ratings company might set the stage for rule changes that S&P helped block in the past.

A finding against S&P “could be an explosive wake-up call that propels financial reform back to the top of the nation’s agenda, where it belongs,” noted Dennis M. Kelleher, chief executive officer of Better Markets Inc., a Washington-based watchdog group. “Regulators may finally stop listening to Wall Street lobbyists and pass rules to protect taxpayers from reckless and risky betting.”

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