Connecticut Attorney General's Office

Press Release

Attorney General Sues Credit Rating Agencies For Illegally Giving Municipalities Lower Ratings, Costing Taxpayers Millions

July 30, 2008

Attorney General Richard Blumenthal today, joined by mayors and first selectmen from across the state, sued the three national credit rating agencies for allegedly giving municipalities artificially low credit ratings, costing taxpayers millions of dollars in unnecessary bond insurance and higher interest rates.

Blumenthal's lawsuit names Moody's Corporation, Fitch, Inc. and The McGraw-Hill Companies (parent company of Standard & Poor's (S&P)).

The lawsuit is the first court action in an investigation -- ongoing since late Fall of 2007 -- that is continuing as to possible antitrust violations, consumer protection and potentially other violations by credit rating agencies, bond insurers and related entities.

All three credit rating agencies systematically and intentionally gave lower credit ratings to bonds issued by states, municipalities and other public entities as compared to corporate and other forms of debt with similar or even worse rates of default, Blumenthal alleges.

As a result of these deceptive and unfairly low ratings, Connecticut's cities, towns, school districts, and sewer and water districts have been forced to spend millions of taxpayer dollars to purchase bond insurance to improve their credit rating, or pay higher interest costs on their lower rated bonds.

"We are holding the credit rating agencies accountable for a secret Wall Street tax on Main Street -- millions of dollars illegally exacted from Connecticut taxpayers," Blumenthal said. "Connecticut's cities and school districts have been forced to spend millions of dollars, unconscionably and unnecessarily, on bond insurance premiums and higher interest rates as a result of deceptive and deflated credit ratings. Their debt was rated much lower than corporate debt despite their much lower risk of default and higher credit worthiness.

"Studies done by all three agencies themselves since 1999 show that public bonds default far less often than corporate bonds with similar, higher credit ratings. In fact, public bonds with low ratings have lower default rates than the highest rated corporate bonds. They have maintained the dual standard to financially benefit bond insurers, investors and ultimately themselves.

"This rating charade created a Wall Street shell game constructed by the ratings agencies for the benefit of the bond insurers -- which enabled the bond insurers to profit from unnecessary premiums and interest paid by taxpayers. All three rating agencies admit and acknowledge -- in their own studies conducted as long as nine years ago -- that states and cities have virtually zero risk of defaulting on loans. Despite their own conclusions, the credit rating agencies purposely concocted a dual rating system, enabling them to impose lower ratings on municipalities than corporations that are far more likely to default.

The lawsuit quotes one senior Moody's credit analyst stating, "I think there is clearly a mismatch between the default data and people's perception of the risk associated with municipal credits."

Blumenthal said, "The credit rating agencies and bond insurers have enjoyed enormous profits, at the expense of taxpayers, as a result of this deceptive dual rating system. The harm to taxpayers across the country is real and substantial. We demand that the dual standard, anti-taxpayer system be stopped and that the rating agencies pay money back to municipalities, as well as penalties and disgorgement of funds. Most important, we seek to end Wall Street's unconscionable costly secret tax on towns and cities.

"Today's action has highly significant national implications for taxpayers across the country, which is why I have been contacting colleagues in other states."

Blumenthal's lawsuit, filed in coordination with Department of Consumer Protection (DCP) Commissioner Jerry Farrell, Jr., alleges the credit rating agencies violated the Connecticut Unfair Trade Practices Act by intentionally misrepresenting and omitting material facts that caused bond issuers in Connecticut to purchase bonds at higher interest rates.

Connecticut's cities, towns, school districts, sewer and water districts, and other public entities hire and pay credit rating agencies to provide a fair and honest opinion of the issuer's ability to meet its financial obligations on the bond. Each of the credit rating agencies purport to measure risk of nonpayment. Driven by improper considerations, the rating agencies failed to provide that fair and honest opinion, Blumenthal said.

Expenses paid by taxpayers for bond insurance and higher interest rates would have been unnecessary if the rating agencies fairly and honesty rated public bonds -- based on the likelihood public bond issuers would pay back their bonds on time.

One central reason for the continued underrating was the coordinated efforts of the bond insurers to convince Moody's to maintain the dual rating system. In 2006, as Moody's considered changing its practices and rate public debt on the same scale as corporate debt, an Ambac executive wrote "did we know this was coming -- at first blush this looks pretty serious to me…This is cutting at the heart of our industry…While we in the industry might agree with the default/loss conclusion (this is in part the basis of our success and ability to leverage as high as we are), to lay it out there like this could be very detrimental."

Another Ambac executive responded, "…we know that hardly anybody reads the Moody's special reports so it didn't matter. However, if they actually assign the higher ratings [to the public debt], that's a totally different story…" After the bond insurers met with Moody's most senior executives they reported back that "Mtg. went well…we were preaching to the choir." Moody's dropped any plans to change from its dual rating system.

Blumenthal's lawsuit details how the credit rating agencies' practices have harmed towns and cities statewide:

STANDARD AND POOR'S

• From 2003 through 2006, the City of Hartford issued six general obligation bonds, and between 2004 and 2005, the City of Norwich issued two general obligation bonds. S&P gave each of Hartford's bonds an "A" credit rating and Norwich's bonds an "A+." As a result of S&P's deliberate underrating of public bonds, Hartford taxpayers paid a total of $925,000 in bond insurance premiums to receive a higher "AAA" rating, and Norwich paid $63,000 for their "AAA" rating.
• From 2006 through 2007, the Town of Windsor issued two general obligation bonds. S&P gave each of Windsor's bonds a "AA" rating. As a result of S&P's deliberate underrating, Windsor taxpayers paid $43,000 in bond insurance premiums to receive the "AAA" rating from S&P.

MOODY'S

• From 2003 through 2008, the City of New Haven issued nine general obligation bonds, and from 2002 through 2006, the City of East Hartford issued five general obligation bonds. Moody's gave each of New Haven's bonds an "A3" rating and each of East Hartford's bonds an "A1" rating. As a result of Moody's deliberate underratings, New Haven taxpayers paid a total of $2.2 million in unnecessary bond insurance premiums to receive a higher "Aaa" rating, and East Hartford taxpayers paid over $150,000 for their "Aaa" bond insurer credit rating.
• Between 2003 and 2006, the Town of Bethany also issued two general obligation bonds. Moody's gave each of Bethany's bonds an "A1" rating. As a result of Moody's deliberate underrating, Bethany paid over $33,000 in bond insurance premiums to receive a "Aaa" rating.

FITCH

• From 2003 through 2007, the City of Bridgeport issued 10 general obligation bonds, and from 2002 through 2007, the Town of Tolland issued six general obligation bonds. Fitch gave each of Bridgeport's bonds an "A-" rating and each of Tolland's bonds either a "AA" or "AA-" credit rating. As a result of Fitch's deliberate underrating of public bonds, Bridgeport paid a total of $2.7 million in unnecessary bond insurance premiums to receive a higher "AAA" rating from Fitch. Tolland taxpayers paid over $120,000 for their "AAA" bond insurer credit rating.
• Between 2002 and 2006, the Borough of Naugatuck issued five general obligation bonds. Fitch rated four of these bonds and gave each of the bonds it rated a "AA-" rating. As a result of Fitch's deliberate underrating of public bonds, Naugatuck taxpayers paid a total of over $31,000 in bond insurance premiums to receive the "AAA" rating from Fitch.

Blumenthal thanked members of his office who worked on the investigation - Assistant Attorneys General Matthew Budzik, Gary Becker and George O'Connell; Paralegal Lorraine Measer and legal intern Rachael Payne, under the direction of Assistant Attorney General Michael Cole, Chief of the Attorney General's Antitrust Department.

View the full complaints:

STANDARD AND POOR'S - (PDF-4,355KB)

MOODY'S (PDF-5,203KB)

FITCH - (PDF -4,802)