Judging The Financial Crisis

According to an article from Bloomberg today, judges are increasingly showing their anger towards the financial community by condemning actions that contributed to the crisis. Bloomberg explains that judges' lack of political pressures paired with their life-long term provides them with a unique opportunity to hold banks, bankers and others involved in the crisis accountable. Although I found most of the examples provided unsurprising or even old news, it did cite one important ruling from last week.

So what are those obvious examples? Judges have been throwing the book at fraudsters like Madoff and others. I doubt such actions are particularly controversial, as few out there probably feel much pity for such individuals.

A little more controversial, but not really news, are judges who are preventing foreclosures. Bloomberg writes:

Judges in Ohio and Pennsylvania have taken unprecedented actions to slow or prevent foreclosures by Wall Street banks as the impact of the recession, including loss of jobs, made it impossible for homeowners to make mortgage payments -- sometimes on homes whose values dropped to less than the amount borrowed.

That's true and significant, but we've been reading about it for months.

There is, however, a kernel of legitimate news in the story:

Last week, U.S. District Judge Shira Scheindlin threw out a key free-speech defense that credit raters had used for years to thwart investors' fraud suits, knocking $1.5 billion off the market value of Moody's Investors Service Inc. and the parent of Standard & Poor's LLC.

Find the entire decision here. This is somewhat serious. Nearly two months ago, I wrote about the precedent that the rating agencies' work is all considered opinion, and thus subject to First Amendment protection. As a result, it had been very hard to sue the agencies when they got it wrong. At that time, I called the idea that the rating agencies should be granted the same free speech protection as journalists "absurd." Since then, I've had several debates with friends about whether rating agencies should enjoy this luxury.

This district judge appears to agree with me -- at least in part. I'm not sure how I missed this ruling last week, but it's pretty significant news. A recent Wall Street Journal article I dug up on the topic provides further detail:

The firms had long argued that their ratings of securities were constitutionally protected opinion. But U.S. District Judge Shira Scheindlin ruled on Wednesday in a 68-page opinion that the ratings of certain securities -- those that were distributed to a limited number of investors -- don't deserve the same free-speech protection as more general ratings of corporate bonds that were widely disseminated.

In truth, it isn't probably as big a deal as some may hope, since it only applies to privately placed bonds. One WSJ source casts some doubt on whether this distinction should hold up:

Martin Redish, a constitutional-law professor at Northwestern University School of Law, questioned whether the judge is correct in seeing free-speech protection for publicly disseminated communication but not for private communication. "The fact that [a rating] was just to a select audience should not disqualify it from First Amendment protection."

I too see the distinction that the judge makes a little dubious. I'm not sure what it means for the First Amendment to count in a public, but not a private, medium. Does that mean journalists need to be very careful what they say in private talks, but can say whatever they publicly? The ruling feels a bit awkward at best.

Still, it's a meaningful departure from precedent. Investors will certainly be getting in line to sue rating agencies if the ruling stands. You may even see some more activist judges decide to strike down agencies' broader First Amendment protection entirely in light of Judge Scheindlin's interpretation, though that could be a long shot. For better or for worse, the rating agencies have traditionally been protected by the courts, and it's very difficult to break precedent.