NYO: You’ve emphatically noted in the past intentional deception as what distinguishes being wrong from lying or from fraud. Much of the outrage directed at S&P when they downgraded American debt was: they failed to downgrade the CDOs and other toxic assets that assisted the 2008 crash, their credibility is shot, ergo, how dare they downgrade our debt. It’s pretty clear that—among the other reasons—they failed to downgrade these products because they’re paid to rate them by the people creating them. From a prosecutorial standpoint, is there an inherent deception in the system?
ELIOT SPITZER: Deception’s a strong word to use without actual proof of intent to deceive. When you look back at all the cases [the New York Attorney General's office] made, we actually had that proof. There were actual deceptive acts taken. I just want that as a backdrop.
NYO: But again, we’re talking about deception on a systemic scale.
ES: Right. There’s a structural flaw and has been forever in the way [ratings agencies] have been paid that’s led to a failure of hard analysis underlying many of their ratings. There should have been prosecutions in the past, there should’ve been a deeper analysis of those conflicts and the tensions that led to very poor analysis.
NYO: How would they’ve been prosecuted, though? It doesn’t seem like there’s an existing statute…
ES: Sure there is, the same way we brought the ratings case against the analysts. All you need is a common law fraud concept that people—and you go back to the emails, just as we did in the analyst case—and again, I’m not saying “let’s relive the past” This is a more theoretical matter. Go through the emails, and you would’ve seen—“this isn’t a triple-A, but they’re a good client, and we’re gonna…”—that tension between what ratings were put on a product, and one’s belief or recognition that they may not deserve it. There are many theories about what would be there, but you have to get the evidence, to state the obvious. I don’t want to say “gee, they should’ve been prosecuted.” But there should’ve been greater scrutiny over the years, and the structure has always been problematic. It was next on our hit parade, if I had been there for that.
NYO: Is there any way to effectively reform this system?
ES: The best answer—and I think the marketplace is moving to this—is to essentially tell the ratings agencies: “You’ve got to earn your credibility.” Let’s remove from them the position they had for many years, which was the government saying “You are designated as agencies to which we ascribe a certain elevated position. And you have been given this power by the government without having earned it.“ There’s no reason for that. And now I’m going to sound like a freemarketeer.
NYO: Haven’t they earned it, though? There are only ten ratings agencies certified by the government.
ES: They haven’t earned it based upon their performance.
NYO: …On the merit of their ratings.
ES: Right. In other words, when I say “earn it,” I mean “earn it” in terms of establishing to the marketplace that your ratings actually mean something.
NYO: Somehow, this hasn’t already happened.
ES: No. [There’s a] notion that there are no straight lines in the world, and what most people do—and understandably—is presume that lines continue in perpetuity. Rating agencies have been uniquely bad at spotting inflexion points, and that is, of course, what you’re paying them to do.
NYO: Not just that, but they’re being paid to be bad.
ES: Anybody can extend the line in the direction in which it has been moving. The hard part is saying “Wait a minute. There’s too much securitized mortgage debt out there, and therefore there’s a problem.” Quality control is lagging, and that’s what we’ve picked up by actually digging into the underlying mortgages.
NYO: That…is what the short-sellers picked up.
ES: That’s what the short-sellers picked up. That’s the sort of analysis the rating agencies should have done, if in fact they had been worth their mettle.
NYO: It’s not exactly a trenchant observation, but isn’t the inherent problem facing rating agencies as they stand that if one takes their bad products to a ratings agency, and they don’t rate it triple-A, you can just take it to the next guy? The free market!
ES: It’s why the rating agencies need to make a determination: either they will maintain their integrity, and they will be paid because people will value them in the marketplace, or you need to come up with a different payment mechanism. I’m not saying any of this is easy. “Who’s going to pay for honest research?” becomes a very difficult question.
NYO: Doesn’t honest research benefit these companies in the long-term?
ES: I’d think so. You need a payment mechanism to those who are going to do the real analysis that will not taint it or, if it’s tainted, let the marketplace know it.
NYO: What do you mean by ‘payment mechanism’? For the government to pay them?