Depending on the details and nature of the documents which Financial Times has received, this looks pretty bad for Moody's. It has all the appearance of a collusion to defraud European investors. "The firm adjusted some assumptions to avoid having to assign lower grades, the paper said." "But the triple-A ratings assigned by Moody's and Standard & Poor's generated controversy, with both Fitch Ratings and DBRS saying they could not justify assigning such high ratings." And for whom was Moody's marking these, what Wall Street bank?
Or, is Moody's the victim of a 'rogue computer' that cleverly bypassed all compliance and common sense as it came up with answers that were supported by no one and nothing else, resulting in millions of fees for Moody's, billions in debt sales for their banking clients, but huge losses for naive European investors?
Dramatization of what went wrong with Moody's trading computer.
Moody's Begins Probe on Report 'Bug' Caused Aaa Grades
By John Glover and Abigail Moses
May 21 (Bloomberg) -- Moody's Investors Service said it's conducting ``a thorough review'' after the Financial Times reported that a computer error was responsible for Aaa ratings being assigned to complex debt securities that slumped in value.
Banks obtained the highest grades in 2006 and 2007 for constant proportion debt obligations, funds sold in Europe that used borrowed money to speculate on an improvement in credit quality. The subprime crisis caused banks including UBS AG and ABN Amro Holding NV to unwind their CPDOs, triggering losses of as much as 90 percent for investors.
Some senior staff at Moody's were aware in early 2007 that CPDOs rated Aaa the previous year should have been ranked as many as four levels lower, the FT reported today, citing internal Moody's documents. The firm adjusted some assumptions to avoid having to assign lower grades, the paper said.
``If it is true, does that mean other products haven't been rated correctly?'' said Puneet Sharma, Barclays Capital's head of investment-grade credit strategy in London. ``Will they be downgraded? It could lead to turmoil.''
Banks created at least $4 billion of CPDOs, promising annual interest of as much as 2 percentage points above money- market rates combined with the highest credit ratings -- described a ``holy grail'' for investors by Bear Stearns Cos. strategist Victor Consoli in a November conference call.
`Integrity'
Moody's and Standard & Poor's stripped CPDOs of their Aaa grades this year as rising defaults in the U.S. housing market increased the cost of credit-default swaps referenced by the funds by as much as 670 percent in the past year.
``The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised about European CPDOs,'' New York-based Moody's said in an e-mailed statement. ``We are therefore conducting a thorough review of this matter.''
Moody's has ``adjusted its analytical models on the infrequent occasions that errors have been detected,'' the statement said. ``It would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors.'' (yes it would. as a matter of fact it might even be criminal fraud - Jesse)
Credit rating firms have come under scrutiny from lawmakers and regulators for assigning their top grades to securities tied to loans to people with poor or limited credit.
``As far as CPDOs are concerned there shouldn't be a material impact'' because the securities have already been downgraded, said Andrea Cicione, a credit strategist at BNP Paribas SA in London. ``Of course there could be a reputational impact for Moody's.''
To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net
Moody's shares slide on report of rating errors
Wed May 21, 2008 10:57am EDT
LONDON, May 21 (Reuters) - Shares in Moody's Corp (MCO.N) fell almost 13 percent on Wednesday after the Financial Times said a computer coding error led Moody's Investors Service to assign incorrect triple-A ratings to a complex debt product.
Moody's said in a statement it was conducting a "thorough review of this matter." A Moody's spokesman would not comment on the report beyond the statement.
Shares in Moody's Corp were down over 12.9 percent at $38.23 at 1554 GMT.
Ratings agencies are under scrutiny by regulators and politicians over the role they have played in the U.S. subprime mortgage crisis, and they face allegations that they assigned ratings that were too high to bonds backed by poor-quality mortgages.
The FT said internal Moody's documents it had seen showed that ratings on so-called constant proportion debt obligations (CPDOs) should have been up to four notches lower, and that the agency had discovered the error in its models early in 2007.
Moody's corrected the coding glitch at that time and instituted changes to its methodology, the FT said. The products remained triple-A until January 2008, when market turmoil led to hefty downgrades.
Moody's said in an emailed statement: "Moody's regularly changes its analytical models and enhances its methodologies for a variety of reasons, including to reflect changing credit conditions and outlooks. In addition, Moody's has adjusted its analytical models on the infrequent occasions that errors have been detected.
"However, it would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors. The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised about European CPDOs. We are therefore conducting a thorough review of this matter." (But they didn't seem to care before they were caught and publicly exposed. - Jesse)
CPDO CONTROVERSY
CPDOs take leveraged bets on credit derivatives indexes such as the iTraxx Europe. They were designed to pay investors very high coupons -- around 200 basis points over Libor -- and yet gain very high ratings.
Dutch bank ABN AMRO pioneered the structure in 2006, calling it "the most exciting development in the credit market for several years." (Sounds like the 'watered stock' approach to selling financial assets which old Daniel Drew was doing in the 19th Century - Jesse)
But the triple-A ratings assigned by Moody's and Standard & Poor's generated controversy, with both Fitch Ratings and DBRS saying they could not justify assigning such high ratings.
Credit market participants too questioned whether the structures were too good to be true. Critics said the performance of the instrument relied more on market risk than on default risk, the traditional area of expertise for the agencies.
Many marveled at the ingenious nature of the structure. "The joke we've been making is CPDOs take a lot of single-A assets, by which we mean ordinary corporate bonds, lever them up 15 times, and -- ta-dah! -- it's triple-A," said Matt King, credit strategist at Citigroup, in November 2006. (Yeah that's a real knee slapper all right. Citi is a real standup comedian. - Jesse)
The extreme market volatility early this year caused very sharp falls in the values of the instruments, and led Moody's and S&P to cut their ratings on the instruments as fears built that investors would end up losing money on them. (after they had already lost it - Jesse)
(Reporting by Richard Barley; Editing by Andrew Callus)
