Does Cuomo's Case Against Wall Street Have a Shot?

After big Wall Street banks posted an incredible perfect quarter of trading, the government is doing what it can to cramp their celebration. Today, New York Attorney General Andrew Cuomo joins the popular cause of accusing big banks of wrongdoing: he is reportedly investigating whether eight big Wall Street banks misled the rating agencies. This follows SEC fraud charges against Goldman Sachs and federal investigations of rating agency Moody's, investment bank Morgan Stanley, and probably others. Cuomo didn't want to miss out on all the fun. But does he have a case, or does he just find big banks a politically convenient target?

In particular, Goldman Sachs, Morgan Stanley, UBS, Citigroup, Credit Suisse, Deutsche Bank, Crédit Agricole and Merrill Lynch (now Bank of America) are in Cuomo's crosshairs. He believes that they provided misleading information to the rating agencies, which led to the high ratings they provided on mortgage-related securities that turned out to be junk. If that occurred, then the banks committed fraud.

From everything we know about the financial crisis, however, it's highly unlikely that misleading information caused these ratings. For starters, the data that banks provided was generally verified through third-party due diligence, so it couldn't have been false or we would have heard about gross fraud by now. Additionally, banks didn't need to lie to the rating agencies -- their mistakes are now pretty obvious. The agencies made poor assumptions, which they shouldn't have relied on the banks to form. Had the housing market continued to rise indefinitely, all those securities would have performed as expected. Of course, that's not what happened.

Moreover, if banks were intentionally misleading the rating agencies about the securities they were creating, then why did they decide to buy so many of them? Remember, the financial crisis was mostly caused by investor panic when nobody knew how much the toxic securities on banks' balance sheets were worth. Those securities are the same ones that Cuomo accuses banks of misleading the rating agencies about. Were they lying to themselves as well? That doesn't make any sense.

Finally, the scope of banks being examined shows how unlikely the investigation is to come up with anything tangible. For all eight of these banks to have been committing fraud by providing false data to the rating agencies, we'd be talking about a conspiracy of epic proportions. Significant collusion and coordination would have been needed to make such a scheme work. Clearly, that's highly unlikely considering how relentlessly competitive these banks are with each other.

The New York Times notes an additional focus of the investigation:

Mr. Cuomo is also interested in the revolving door of employees of the rating agencies who were hired by bank mortgage desks to help create mortgage deals that got better ratings than they deserved, said the people with knowledge of the investigation, who were not authorized to discuss it publicly.

While this revolving door likely resulted in stronger relationships between bankers and rating analysts than would have been ideal, it's hard to see how there's anything criminal here. The implication would have to be that the rating agencies intentionally rated these bonds higher than they would have otherwise to appease the banks. Yet the ratings went bad due to poor assumptions. For fraud, analysts must have intentionally misled investors about those assumptions. So unless investors were told that these mortgage bonds could sustain a massive housing market failure, while the rating agencies actually believed they couldn't, then there could have been no fraud. Though ethically questionable to adopt liberal assumptions to please bankers, there's nothing illegal about that unless you mislead investors about those assumptions.

So Cuomo likely doesn't have much of a case, unless he has managed to uncover some grand fraud conspiracy with the banks providing fictitious data to the rating agencies. Instead, he's likely just playing politics. Given the populist call to crack down on Wall Street, you can hardly blame him from a political perspective. But other than the bad publicity, these big banks probably don't have to worry much about these accusations.