One reason why rating agencies may be downgrading US banks is because of the extraordinary Jed Rakoff opinion, blocking the settlement between the SEC and Citigroup. Matt Taibbi examines the settlement today:

Rakoff’s 15-page final ruling read like a political document, serving not just as a rejection of this one deal but as a broad and unequivocal indictment of the regulatory system as a whole. He particularly targeted the SEC’s longstanding practice of greenlighting relatively minor fines and financial settlements alongside de facto waivers of civil liability for the guilty – banks commit fraud and pay small fines, but in the end the SEC allows them to walk away without admitting to criminal wrongdoing.

This practice is a legal absurdity for several reasons. By accepting hundred-million-dollar fines without a full public venting of the facts, the SEC is leveling seemingly significant punishments without telling the public what the defendant is being punished for. This has essentially created a parallel or secret criminal justice system, in which both crime and punishment are adjudicated behind closed doors.

Judge Rakoff blew a big hole in that practice yesterday. His ruling says secret justice is not justice, and that the government cannot hand out punishments without telling the public what the punishments are for. He wrote:

Finally, in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.

The rhetorical flourish is definitely righteous, indicative of the troubling slip into a two-tiered system of justice in America, one for the rich and powerful and one for the rest of us. The fact that Chuck Grassley endorsed the Rakoff decision is noteworthy. But in addition, there’s a real-world consequence to Rakoff’s ruling, because he’s forcing a jury trial. As Marcy Wheeler explains, the SEC made a separate complaint against a Citi employee named Brian Stoker, who the SEC asserted knowingly sold the mortgage backed securities while the firm shorted the other side. Rakoff joined that case with this settlement, and in Marcy’s words, he effectively said “If you’re prepared to prove that Stoker knew what he was doing in selling shitty MBS, you’re prepared to prove that Citi did too.”

This would be really terrible for Citi. They would be on the hook for criminal violations and would be exposed to having any investor victimized by an MBS deal to sue them. This widens the exposure considerably. The SEC is scrambling by trying to get Congressional approval for higher penalties for offenders. But that is probably just a try to make a big enough settlement to get the likes of Rakoff off their backs. In this sense, a bigger settlement would SAVE Citi, because it would reduce their ultimate exposure.

This could lead to the dissolution of big banks. Sadly, there’s only one Presidential candidate taking these matters seriously, and that’s Jon Huntsman. But the judicial system may be stepping in where executive and Congressional leadership has utterly failed. And let’s hope so: bank size and the overall financial industry share of the economy has a serious dampening effect on growth.