Archive for May 21st, 2008

Moody’s tries to save itself

May 21, 2008

FT has done a detailed analysis of Moody’s modelling error that gave top rating to complex financial instruments.

The article is only for subsribers but alphaville blog provides some ideas of what was going on. I found this pretty shocking:

Internal Moody’s documents seen by the FT show that some senior staff within the credit agency knew early in 2007 that products rated the previous year had received top-notch triple A ratings and that, after a computer coding error was corrected, their ratings should have been up to four notches lower.

Four notches lower? This is simply unacceptable. Even if there was a model error (which is quite common) one can’t get a lower rated product become a super rated category. And one can still understand these things happen at a fund but how can they happen at a credit rating agency. Surely, there is back-testing and other kinds of risk assessment tests which would have separated wheat from the chaff. As I had asked earlier, What were the risk managers doing?

What is also shocking is this:

On discovering the error early in 2007, Moody’s corrected the coding glitch and instituted methodology changes. One document seen by the FT says “the impact of our code issue after those improvements in the model is then reduced”. The products remained triple A until January this year when, amid general market declines, they were downgraded several notches.

So despite finding the error, the products remained AAA till the crisis happened. This from a credit rating agency is just not accepted. And on top of this we have to hear such fancy/lofty statements:

“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.”

Actually none of this is new. I remember reading a lot of material in time of Enron and Worldcom meltdown. Very similar things happened then and it is sad that nothing has changed.

The blame lies with people and not models per se. I just fail to imagine that the error wasn’t known. You have a lot of people verifying the initial documents and it doesn’t require rocket science to figure out the problem that a subprime asset has got a AAA rating. If it was a standalone crisis surely more would have come out about why thesedeals were taken up. Now because the crisis has affected all, the blame is being shifted to other factors like poor markets, models (as if they were created in vacuum) etc.

Credit Rating Agencies are supposed to be really honest in their conduct as lots of market activity depends on them. And it is not good that they also follow the path of other financial intermediaries. On this you might also like to read a superb article by Roger Lowenstein very nicely titled- Triple A failure.


Assorted Links

May 21, 2008

1. WSJ Blog points to battle between headline and core prices

2. SandM Blog on BoE problems

3. Fin Prof points to advice for sound financial future

4. Ecobrowser on oil prices

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