The Most Expensive Political Scandal of the Century?

Forget “Bridgegate” or the IRS Tea Party scandal. There may be a bigger, far more costly, far more damaging scandal that may be ready to burst on the scene in just a matter of months.

This week, allegations came to light that former Treasury Secretary Timothy Geithner had told the head of Standard & Poor’s, the credit rating agency, that “S&P’s conduct would be looked at very carefully” in the aftermath of S&P’s downgrade of the US “AAA” credit rating.  “Such behavior would not occur… without a response from the government,” Geithner said, according to allegations made in court documents.  The conversation is alleged to have occurred Timothy Franz Geithneron August 8, 2011, a Monday.  S&P had announced its downgrade of US debt late in the evening the prior Friday, shortly after 10:00PM.  Secretary Geithner had repeatedly stated in the months leading up to the downgrade that there was no chance such a downgrade would occur.

In February of 2013, the Justice Department brought an action against S&P and its parent, McGraw Hill, for civil penalties related to alleged fraud in S&P’s rating of Residential Mortgage Backed Securities (“RMBS’s”) and Collateralized Debt Obligations (“CDO’s”) purchased by  banks and other financial institutions.

None of the other major credit agencies have been so accused, so one could easily draw the implication that former Secretary Geithner’s alleged threat of “a response from the government” was realized in the form of the Justice Department actions.

The Justice Department denies its prosecution of S&P has any relationship to former Secretary Geithner’s alleged conversation of August 8, 2011.  A Justice Department spokesman says his department had begun its investigation into S&P’s ratings of RMBS’s and CDO’s well before August, 2011, and that its current action against S&P – alone – for its allegedly fraudulent ratings is simply coincidental.

Let’s hope so.  But let’s also verify it by holding Congressional hearings, because the cost of even a threatened reprisal is incredible.

It’s hard for one to overstate the damage to the financial markets, to taxpayers, and to lenders that would come about if it were determined that credit ratings agencies were the victims – or even the suspected victims — of political reprisal by the government for their Standard&Poors ratings of sovereign debt, whether it be the debt of the United States, individual states, or foreign countries. A president could theoretically have the power to punish or favor states or foreign countries at his discretion. The ratings of all sovereign debt would be suspect and all sovereign debt would carry a higher risk premium – and thus a higher interest rate — because lenders would know the ratings were so corrupted as to be worthless. It would be akin to baseball fans knowing that the Chicago “Black Sox”, infamous for having thrown the World Series in 1919, had escaped punishment with a small fine and an apology.  If the World Series – or even major league baseball survived — it would be little more than a home run derby; a spectacle with as much suspense about the outcome as professional wrestling.   It would hardly be “the fall classic”.

Indeed, if S&P’s allegation were to be proven true and it were proven the Obama Administration had engaged in political reprisal because S&P downgraded US debt, the proof of the  act of reprisal would do far greater damage to the US credit rating – and all sovereign debt — than the downgrade itself.   It will cost taxpayers far, far, more in higher interest rates to compensate for the greater perceived risk to US debt than anything short of default.  And since the interest rate on private sector debt is higher than the “risk free” debt of the United States, interest costs for businesses, governments, and individuals would move higher.

If it’s proven that the Justice Department prosecuted S&P as reprisal for its downgrade of US debt, it would be the biggest and most costly political scandal of the 21st Century, so far.

Congress should take it very seriously. So should you.

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