Moody's Stock Craters on Revelations it Marked Dodgy Debt Aaa for Sale to Europe - Blames a Computer

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)

Economists Discover the Law of "Separate but Equal"

On June 9, the 30th day of the McCarthy Army hearings, Army Defense Counsel Robert Welch challenged Roy Cohn to provide McCarthy's list of 130 Communists or subversives in defense plants "before the sun goes down."

McCarthy stepped in and said that if Welch was so concerned about persons aiding the Communist Party, he should check on a man in his Boston law office named Fred Fisher, who had once belonged to the National Lawyers Guild, which Attorney General Brownell had called "the legal mouthpiece of the Communist Party."

Welch responded, "Until this moment, Senator, I think I never gauged your cruelty or your recklessness..."

When McCarthy resumed his attack, Welch interrupted him: "Let us not assassinate this lad further, Senator. You've done enough. Have you no sense of decency, sir, at long last? Have you left no sense of decency?" When McCarthy once again persisted, Welch cut him off and demanded the chairman "call the next witness."

At that point, the gallery erupted in applause and a recess was called.

Until this moment I think I never gauged the cruelty or recklessness of some conservative economists, politicians and their masters the Pigmen. They have created a wreckage of financial devices and led us on the edge of a societal precipice. Have they not done enough? Have they no sense of decency left at long last?

Must they now attempt to define the poor as those who by their nature prefer cheap and shoddy goods, and a lower standard of life, and who are therefore are separate but equal with the wealthy who are genetically compelled (entitled?) to require the finer things in life?

The words to lowlifes like McCarthy and Cohn still fit after all these years, to those lacking the basic integrity of the schoolyard, who thrive on and generate conflict, and who will say or do almost anything in their pursuit of the will to power.

Inequality and Prices
May 20, 2008
Lane Kenworthy’s weblog

Steven Levitt and Will Wilkinson point to a new paper that Levitt says “shatters the conventional wisdom on growing inequality” in the United States. The paper is by Christian Broda and John Romalis, economists at the University of Chicago.

Here’s their argument: income inequality has increased over time. But analysis of consumption data indicates that people with low incomes are more likely than those with high incomes to buy inexpensive, low-quality goods. In part because those goods increasingly are produced in China, their prices rose less between 1994 and 2005 than did the prices of goods the rich tend to consume. Hence the standard measure of inequality, which is based on income rather than consumption, greatly overstates the degree to which inequality increased. The incomes of the rich rose more than those of the poor, but because the cost of living increased more for the rich than for the poor, things more or less evened out.

Their point that the prices of some goods have risen less than the overall inflation rate, and that this is due in large part to imports from China, seems perfectly valid and worth making. It has important implications for our understanding of how absolute living standards for America’s poor have changed over time.

But I’m not sure why Broda and Romalis, or Levitt and Wilkinson, think this should alter our assessment of the trend in inequality. Do they mean to suggest that the revealed preference of the poor for cheap goods is exogenous to their income? In other words, people with low incomes simply like buying inexpensive lower-quality goods, and they would continue to do so even if they had the same income as the rich. Likewise, the rich simply have a taste for better-quality but pricier goods, and they would continue to purchase them even if they suddenly became income-poor. If this is the assumption, I guess the conclusion follows. But I can’t imagine the authors, or anyone else, really believe that.

Actually, Levitt may believe it. “How rich you are,” he says, “depends on two things: how much money you have, and how much the stuff you want to buy costs” [my emphasis - LK].

Consumption is worth paying attention to. But income is important in its own right because it confers capabilities to make choices. What matters, in this view, is what you are able to buy rather than what you want to buy.

If a rich person with expensive tastes gets an extra $100,000, she can continue buying high-end clothes and gadgets. Or she can choose to purchase low-end Chinese-made products and save the difference. Suggesting that if she opts for the former there has been no rise in inequality is not very compelling.

Moody's Cuts Bond Insurer to Junk

Moody's slashes CIFG unit to junk on capital woes
Tue May 20, 2008 1:46pm EDT

NEW YORK, May 20 (Reuters) - The bond insurance arm of CIFG Holding Ltd was slashed to junk status by Moody's Investors Service on Tuesday, due to concern about its capital position.

Two months ago the insurer held pristine "Aaa" or "AAA" ratings from the major rating firms. Rating cuts and downgrade warnings of bond insurers, including MBIA Inc and Ambac Financial Group, had roiled financial markets earlier this year. (They are insolvent, we're just too scared to admit it - Jesse)

However, the impact of subsequent rating cuts has been muted as many investors already had accounted for potential cuts and losses at the bond insurers before the rating companies completed their reviews.

Moody's downgraded the insurance financial strength ratings of bond insurer CIFG Guaranty, CIFG Europe and CIFG Assurance North America, Inc to "Ba2," two levels below investment grade, from "A1," the fifth highest, and kept the ratings under review with uncertain direction.

The rating cuts "reflect the high likelihood that, absent material developments, the firm will fail minimum regulatory capital requirements," due to losses stemming from its debt and exposure to subprime mortgages, Moody's said.

In March, Moody's had estimated CIFG's expected loss on asset-backed collateralized debt obligations at $433 million, and stress losses, consistent with a 21 percent cumulative loss on 2006 subprime mortgage first liens pools, at $1.3 billion.

"The breach of such regulatory capital requirements would put the firm in a precarious position," Moody's said in a statement, due to the company's exposure to credit default swaps, Moody's said.

CIFG in March asked Fitch Ratings to withdraw ratings for its CIFG Guaranty unit and two affiliates, citing lack of confidence in Fitch's methods. (Fitch is excessively honest - Jesse)

The two other major rating firms, Standard & Poor's and Moody's, earlier this year stripped CIFG of its top "AAA" rating, and Moody's move on Tuesday shows how fast a top rating can turn into junk status.

"The review with direction uncertain reflects potential changes in the credit profile of the firm that could occur over the next couple of months as CIFG attempts to implement capital strengthening plans," Moody's said.

(Reporting by Walden Siew; Editing by Leslie Adler)

What Will the Banks Do Now?

Nouriel Roubini asks an excellent question, and it deserves some thought. We include only a brief excerpt, cutting to the chase as it were. The entire piece can be read here.

For the short term the investment banks can live off the public dole, scamming lunch money by short term manipulation of the markets, and copping the odd fee or so from corporations that have not fallen by the wayside.

In the longer term there will be far fewer money center banks, more small and regional banks, and more a return to banking regulations.

Certain parts of the economy are going to be dead money for a long time. The pit traders are going to get a lot of practice making paper airplanes.

The hope will be that the corporate sector will build up its cash reserves, start capex spending to regenerate the real economy, and of course buy up competitors generating goodies for Wall Street.

There will be an effort to find fresh countries to despoil overseas.

The US financial system is a teetering wreck, and a significant amount of liquidation and consolidation lies ahead of us. The problem with bankers in key roles like the Fed is that they NEVER like to see a bank fail, so they keep propping up losers far beyond their natural life, wasting dear resources for the real job ahead, infecting society with the stench of rotting Ponzi schemes.


How will financial institutions make money now that the securitization food chain is broken?
Nouriel Roubini
May 19, 2008

The most severe financial crisis in decades has not only damaged the balance sheet of financial institutions. It has also severely affected their P&L, i.e. the process of generating revenues and profits. ....

So how will mortgage brokers, banks, broker dealers, monoline insurers, rating agencies generate revenues and profits now that this slice & dice scheme has unraveled? The current market delusion that the worst is behind us for financial institutions is based on the view that most of the writedowns of the toxic assets have already been done.

But this is not just a balance sheet problem. Now financial institutions have a more severe P&L problem, i.e. how to generate income and earnings from now on when they cannot originate junk any more. The entire income generating model of financial institutions – make income out of securitization fees rather than by holding the credit risk - is broken now that the generalized credit bubble (not just subprime mortgages) has burst; thus, how will these financial institutions generate earnings over time?

Capital losses are one-time problems; but destruction of the income generation process is a more severe and persistent problem that will require banks and other financial institutions to rethink their overall business model of credit risk transfer. But there is no clear and sound new business model for them: going back to the old days of “originate and hold” is not fully possible while the new “originate and distribute” model has shown all of its wrong and distorted incentives, risks and systemic failures.

So banks and other financial institutions will have to seriously rethink their business model and how they are going to make money: the model of slice and dice and pile fees upon fees and transfer the credit risk is broken. It is not clear if banks and other financial institutions have a better model. May they will have to go back to old fashioned banking: carefully assess the creditworthiness of their borrowers, lend on sensible terms and hold a good part of the credit risk now that the easy fee/profit generating machine of securitization is terminally broken.