California joined the federal government, 15 other states and the District of Columbia this week in suing Standard & Poor’s credit rating agency for its role in the housing debacle and financial collapse that began in earnest five years ago.

California’s lawsuit, filed Tuesday in San Francisco Superior Court, seeks $4 billion in damages for S&P actions the state claims cost California’s giant pension funds $1 billion. S&P is accused of claiming rating securities as safe and sound although they allegedly knew they were not. The state is seeking triple damages under the False Claims Act.

California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS) were both large investors in mortgage-backed securities and other financial instruments rated by S&P.

S&P, the largest of the nation’s big three securities rating agencies (along with Moody’s and Fitch), has fended off legal actions by claiming a First Amendment Right to offer opinions to paying customers. But the lawsuit filed by California Attorney General Kamala Harris argues that the company knew its pronouncements were false and, therefore, unprotected speech.

The following are 10 reasons, mentioned in the California lawsuit, why the state thinks S&P is culpable. The state alleges that: 

1. In April 2007, two S&P analysts described the company’s willingness to rate a “ridiculous” deal thusly: “It could be structured by cows and we would rate it.”

2. One analyst described how calculations were “massaged” to produce “magic numbers” and “guesses” to rate deals.

3. The director of servicer evaluations warned in September 2006 of a “powder keg” mortgage market after hearing from the head of U.S. RMBS Surveillance that “underwriting fraud; appraisal fraud and the general appetite for new product among originators is resulting in loans being made that shouldn't be made.”

4. S&P “starved key rating and monitoring groups of staff and needed resources as an excuse to avoid losing business.”

5. The agency “weakened its rating criteria in a race to the bottom with Moody’s,” one of the two other big rating agencies.

6. S&P tried to deny a connection between the potential default of a particular bundled asset and the security based upon it by applying a “fanciful correlation and related criteria to keep ratings high.”

7. “Intentionally ignored” the payment-in-kind (PIK) stress test “to please insurers.”

8. “Intentionally ignored” its own rating policy for collateralized debt obligations. (CDOs).

9. “Used ‘arbitrary’ tricks and ‘tweaks’ to the CDO model.”

10. “Failed to disclose its ‘house-of-cards’ ratings process” for CDOs.

–Ken Broder

To Learn More:

Feds Sue S&P for High Ratings of Mortgage Bonds before Crisis, Seek up to $5 Billion (by Daniel Wagner and Christina Rexrode, Associated Press)

California Accuses S&P of Deception in $4-Billion Lawsuit (by Alejandro Lazo, Los Angeles Times)

California Sues Standard & Poor’s, Boosting CalPERS’ Case (by Dale Kasler, Sacramento Bee)

In S&P Case, Government Says Bond-Rating Firm Put Profits First (by Andrew Tangel and Alejandro Lazo, Los Angeles Times)

U.S. v. McGraw Hill Companies Inc. and Standard & Poor’s Financial Services (U.S. District Court Central District of California) (pdf)