“Computer Glitch” at Moody’s Awarded AAA Credit Ratings to Debt Products that, “Were Like Something Out of a Sci-Fi Blockbuster”
May 21st, 2008Via: Financial Times:
When the craze for CPDOs erupted in financial markets in late 2006, some observers quipped that these new products were like something out of a sci-fi blockbuster.
Not only was the ingracious acronym amusingly close to C3PO, one of the hapless robots from the Star Wars movies, but also like the heroes of Star Trek the products seemed “to boldly go” where no credit product had gone before.
In a time of ever shrinking returns from investments in credit at the height of a raging bull market, early versions of these highly structured and complex deals promised to pay 200 basis points – that is 2 percentage points – over Libor, or the “risk-free” rate at which banks lend to each other. And that spread came with the top-notch triple A ratings that indicate an incredibly low probability that investors could lose their money.
To put this spread in context, triple A rated European prime mortgage backed bonds at the time typically paid less than 20bps, more than 10-times smaller than the CPDO – constant proportion debt obligation – coupon, for example.
However, the triple A ratings that Moody’s awarded to some early deals were based on a model that contained an error in its computer coding and these ratings should have been up to four notches lower, according to internal documents seen by the Financial Times. Billions of dollars could have been affected.
The very first deals from ABN Amro in August 2006, which were rated triple A by Standard & Poor’s alone, provoked huge excitement among bankers, investors, traders in the underlying credit markets and of course the media. Moody’s followed up with its first rating of an ABN Amro CPDO in late September 2006.
By December, a range of banks had copied the deal and this new kind of product had been credited by some with adding new impetus to the rally in corporate credit – a rally which meant that a number of the follow-up products could not pay the same high returns promised by the original deals.
…
It was nothing more than a mathematical typo – a small glitch in a line of computer code. The impact of the “bug” Moody’s analysts discovered was, nevertheless, significant.
When the model was re-run it became clear that the CPDOs could no longer achieve triple A ratings, according to documents seen by the FT.
The results showed that early CPDOs might lose between 1.5 and 3.5 notches in the Moody’s Metric, an internal measure, which equals up to four ratings notches.
Some Moody’s analysts had concerns. With so many transactions from other banks in the rating pipeline, the code could not be left as it was. The bug was corrected.
Best of all, they managed to squash the bug without effecting a severe ratings change.
This is one of those stories that makes me go huh, maybe we aren’t ruled by an evil conspiracy but rather a pack of blundering fools.
Since the core product of Moodys is debt ratings, you would think they would have checked their code. Then again, management there is probably so stupid that it would not occur to them that there might be an error in their code. Then again, THIS story may just be a CYA plant to explain their poor performance rating all this toxic paper.
In any event, why in gods name does anyone pay any attention to these fools? Obviously (and for some time) their debt ratings have meant nothing. AFAIC anyone who make a financial decision based upon a Moodys rating is also a damned fool.
The fact that they continue to be followed is proof that most of the financial world is managed by scared little fools unable to think their own thoughts.
Surely, a change is coming.