Moody's blames "the computer" for possible ratings fraud - 23-May-2008 - Generational Dynamics

Generational Dynamics Web Log for 23-May-2008

Moody's blames "the computer" for possible ratings fraud

A formerly undisclosed software bug is responsible for awarding AAA ratings to worthless securities, according to the company.

An investigation conducted by the Financial Times has revealed that:

Moody's Investors Service discovered in early 2007 that a software bug in its ratings software had erroneously given certain securities AAA ratings, when they should have been given considerably lower ratings, according to Moody's own methodologies.
The securities were "constant proportion debt obligations" (CPDOs). These are more complex than CDOs, and they're backed by corporate credit default swaps (CDSs), rather than mortgage-backed securities (MBSs). You don't have to understand this paragraph to follow the rest of this story, but if you're interested you can find a discussion of the math behind CDOs in "A primer on financial engineering and structured finance."

Moody's did not disclose the software bug, nor did it re-rate the CPDOs.

Instead, it changed its methodologies so that the CPDOs could still be rated AAA.

Documents discovered by the investigation appear to indicate that Moody's officials were less motivated by a desire to tell the truth, and more motivated by a desire to continue charging fat fees in return for AAA ratings.

If these statements can be proved in court, they indicate clear fraud on the part of Moody's.

Moody's issued the following press release in response:

"Moody's recognizes the seriousness of questions raised by today's Financial Times article concerning the analytical models and methodologies used in our European constant-proportion debt obligation (CPDO) ratings process. The integrity of our ratings and rating methodologies is extremely important; as such, when the questions were recently raised to us, we retained the law firm of Sullivan & Cromwell and initiated a thorough external review of our European CPDO ratings process. Upon completion of the review, we will promptly take any appropriate actions.

Moody's rated 44 European CPDO tranches, representing approximately $4 billion in rated securities."

As I've said many times, the circumstantial evidence indicating fraud by banks, ratings agencies, and "monoline" insurance agencies issuing worthless CDOs and CPDOs is obvious: The issuance of CDOs accelerated in 2007, when it was already undeniable that the real estate bubble was bursting, and the AAA ratings clearly couldn't be sustained. And yet, banks continued selling worthless securities, ratings agencies kept rating them AAA in return for fat fees, and "monoline" insurance agencies kept insuring them in return for fat fees.

But this investigation into Moody's Investors Service goes well beyond circumstantial evidence into specific evidence of fraud. My expectation is that there'll be a lot more such investigations, and a lot more fraud discovered. (23-May-2008) Permanent Link
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Generational Dynamics Web Log for 23-May-2008 Moody's blames "the computer" for possible ratings fraud

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Generational Dynamics Web Log for 23-May-2008
Moody's blames "the computer" for possible ratings fraud