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Coding Flaws Caused Moody's Debt Rating Errors
An anonymous reader writes "The Financial Times has the story that billions in incorrect AAA ratings given out by Moody's were the result of a coding error in its computer models. '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.'"
The problem is that the credit agencies used past data for new types of asset backed securities. While this works with most asset backed securities, the use of CDOs and MBSs caused a perfect storm. They assets they were backed up with were housing values and the AAA ratings they had made them very popular, inflating the housing values. When the housing values took a nosedive, there were no assets to back up these securities.
This isn't a trivial issue. False AAA ratings are what have caused the global credit crunch and mortgage crisis. For those who aren't familiar with a AAA rating, it is considered as good as a US government bond. It is a very hard rating to get and only 8 US companies are rated AAA by all of the credit agencies.
In my opinion, there is a very strong need for regulation of the credit agencies. If they didn't allow for CDOs and MBSs to get AAA ratings, this credit crunch and likely recession wouldn't have occurred.
To be fair the OpenSSL problem wasn't caused by the OpenSSL developers. It was an idiot (or two) that hacked up shit when they obviously had no skill.
I worked in a predatory lending clinic for the last few months (as part of my last semester of law school).
In many of our cases, the buyers didn't lie at all. Instead, the broker modified income and employment information on the application forms it sent to the lender, sometimes forging applications entirely
Lenders, for their part, turned a blind eye to obviously suspicious information (like a security guard making $80,000/year).
This worked for both lenders and brokers in the short term because the broker was only interested in getting more business written and the lender would quickly sell the obviously flawed mortgage to someone else.
Of course, all of this resulted in a lot of borrowers getting approved for products they couldn't afford. Why did they apply for such products? Because brokers often flatly misrepresented the terms of the products.
The incentive to get business done at any cost was a major cause of the outright fraud that underlies the current housing crisis. Borrowers are not totally blameless, but lenders and brokers were the really evil parties here.
Very possible.. banking coders tend to be rather cowboy-ish in my limited experience of Investment Banking companies in the UK and Australia.
In a short 5 week stint in an investment bank in Australia I was shocked at the way my manager at the time would order the DBA to "just authorise" some SQL query he'd written on the production database.
The idea of having a DBA authorise a query on the production databases was to prevent stupid things from happening.. but all too often I saw these safety systems bypassed at a human level.
If you want reliable safe systems, I'd bet on telecommunications companies rather than banks.
No, the buyers were evil too. It was common for the buys to be fully aware that incorrect information was going on their applications, and while I have no doubt a lie was told here and there to the buyers, I cannot count the number of people who were openly bragging that it didn't matter that they couldn't afford their loans because they wouldn't own their house long enough for the higher rate to kick in.
That being said, the lenders were definitely committing crimes. Both of the lenders my wife worked for before the crash were committing crimes on an hourly basis. The funders were expected to keep a stock of different pens at their desks to modify documents and signatures. It was common for my wife to come home worried that they were going to fire her because she wouldn't forge documents. "When the police come in to make arrests, the management is NOT going to protect you." and "It is more expensive to spend time in jail than it is to get fired." became mantras in our house.
I'm not sure you've got the right end of the stick, here. "formal verification" doesn't mean "code review by some officially-sanctioned third party". It means "verification using formal methods".
As such, the only cost is time. People already volunteer their time to work on open source projects; there's no particular reason [other than mind-numbing tedium] why they wouldn't volunteer time for this too.
Repton.
They say that only an experienced wizard can do the tengu shuffle.
That actually is (used to be?) a tax dodge.
Take the money you want sheltered. Spend all of it on buying stock and selling an equivalent amount short. If the stock plummets, write the purchase off on your taxes. If it soars, write the short off on your taxes.
Step 3: Profit. Anyone taking notes should question why we have such a screwed up tax system.
DATABASE WOW WOW
Countrywide is having trouble because it is hard to get people to buy houses right now. It's also possible that they got stuck with some loans which they made with the intention of selling immediately but which quickly became unsaleable.
The reason why banks are having trouble is more interesting. Basically banks loaned money to the financial organizations that were buying the mortgages. The mortgages went south, taking the financial organizations that owned them into risk, leaving the banks at risk. Bear Sterns was an example of a financial organization that owned mortgages.
Pension funds should not invest in real estate. Why? Because most people with pensions already own real estate (i.e. their houses). Further, pension funds have limitations on the risk level of securities they own. Finally, unlike banks, pension funds don't loan money. The pension funds chief vulnerability here is to owning a financial organization that goes bankrupt. One example is http://www.nypost.com/seven/03152007/business/mortgage_disaster_in_the_classroom_business_roddy_boyd.htm
Even there, a half way competent management of the fund would have avoided the issue. Why did the pension fund own two million shares? That looks to be about a quarter of the outstanding shares: http://finance.yahoo.com/q?s=NCBC
A lot of the lenders didn't have the money needed to make the loans. They would make loans, package them and sell them and the money that they made from selling the loans would finance the next batch of loans that they were packaging.
Without a steady cash flow from selling mortgages, they can't make any new loans. So when companies stopped buying mortgage securities, their cash flow dried up and they couldn't make any more loans. Game over.
"When you sit with a nice girl for two hours, it seems like two minutes. When you sit on a hot stove for two minutes, it
For an excellent end-to-end journalistic account of the subprime bubble, I highly recommend the recent This American Life episode:
http://www.thisamericanlife.org/Radio_Episode.aspx?episode=355
(Unfortunately, link does not contain a podcast, though it does link to a shorter All Things Considered version of the story.)
An hour-long insightful and comprehensive examination from many different angles.
Innovation makes enemies of all those who prospered under the old regime... -- Machiavelli
If I ever encounter software that looks like that in a business outside of compiler/language design or mathematics, my immediate reaction would be svn blame followed by an angry conversation with the guilty party. Just because it's possible to write software that's formally hard to prove things about doesn't mean it's good to do so.
The borrower signed on the dotted line for their monthly obligations; they don't need the lender to tell them whether they can afford that.
Maybe you didn't catch any of the "seminars" that real estate and mortgage companies had going back in the early part of this decade. A friend of mine convinced me to go to one and this is what they tried to hammer into the audience for a couple of hours:
1 - Personal income always increases over time.
2 - The value of real estate always increases over time.
3 - ARMs are to the buyer's advantage (not the bank's), because no one lives in a house for more than five years anymore.
Therefore, everyone should spend as much money as possible on a mortgage, because they are guaranteed to come out ahead.
There were certainly some weasel words used that would probably get them out of any legal trouble for what they said, but that was the point they were trying to convey. And this was before the *really* dangerous types of loan came into play, like the ones where the monthly payment didn't even cover the interest.
I still believe that the buyers should be held accountable for the contracts they signed, but the real estate industry has only itself to thank for its shortsighted cannibalization of an entire market.
"...always new atoms but always doing the same dance, remembering what the dance was yesterday." -Richard Feynman
Here is a link from the shadowstats site to their well hidden free report, or rather some of their free FUD:
http://www.shadowstats.com/article/292
A summary of this FUD might be that it is about what American residents can do to prepare for a depression coming RSN. It gets even more absurd the FUD paper mentions how the US dollar will undergo seven to ten digit percentage hyperinflation RSN. It also gives questionable suggestions like buying "financial hedges" like gold, and using the gold and other items in barter transactions after the coming "calamity" when the US dollar loses its value.
The author backs up his statements with misleading graphs, no explanation of the methodology used to generate the figures for the graphs. There is a source given for the original data in the graphs, however the author has given no links back to in order to find the original figures so that one could to duplicate the results from the graphs. The first graph in the report has continuous inflation numbers for the US going back to 1665 and no explanation of the relevance of these figures to today's situation, 333 years later. Additionally, for this first graph, the author also prominently inserts some of his own unsourced data. The line for his data starts at a similar position as the line for the other data on the graph and the values increase geometrically which badly distorts the vertical scale. The author also chooses colors for the lines that allow his data to obscure the more continuous figures. The extraneous figures on the graph from before 1946 and the author's added data makes the graph nearly impossible to analyze at all. Even worse, all of the graphs are extremely misleading like the first graph. The entire piece is egregiously bad FUD. I would assume the rest of the site contains more too.
In any case, if a situation occurred which caused a total breakdown in order and social structure, Gold and other precious metals would be of the same value as a small chunk of basalt, optionally painted with acrylic paint with suspended crushed pyrite used as a pigment. In this case Gold have no value. In such a situation where Gold was worthless, the one of the ways Gold could regain value is due to its scarcity, it could be used as currency in a small regional market. However, the value of Gold would come from being scarce which would make it a "fiat" currency. Also, Gold would not necessarily regain much value because it has few applications in many manufactured items. Additionally, other metals and alloys could be used instead if Gold was scarce.
Impersonating Tycho from Penny Arcade since before there was a PA.
AAA Muni bonds have a lower coupon rate not because they are safer than AAA Corporate bonds, but because in the USA they are mostly tax free. [Your milliage may very depending on bond and the state that you live in]. You donâ(TM)t have to pay intrest on most muni bonds. So, if you are in the 50% tax bracket [because you are living in NYC and are paying Federal, State and City Income tax] a corporate bond yielding 4% and a muni bond yielding 2% put exactly the same amount of money in your pocket. So you donâ(TM)t care. Itâ(TM)s nothing about safty.
The lenders weren't selling securities. They were selling lots of mortgages to Wall Street firms which were packaging them into securities. To make the initial mortgages they were leveraged, sometimes at rates of 10:1 or higher. They were borrowing all the money they were lending out and then selling the mortgages to pay off the loans. When stuff started to take a nosedive, the people high on the foodchain stopped buying the high-risk mortgages, leaving the the little guys stuck with bad mortgages and no way to pay off their debt.
Not if you're using the right formal methods... the whole point behind most code verification approaches is that it can be verified automatically. If a human had to review the proof, then sure, this will never work, but if you're using proof-carrying code in a relatively formal language, the verification can be an automatic part of the process.
The point about having programmers who are capable of writing those kinds of code is still valid -- there are lots of them, but it's definitely a smaller set than the people who can usefully contribute to an OSS project today -- but verification is more a question of building good technical infrastructure rather than finding infallible coders...
I am the man with no sig!
Now, this phenomenon is pretty well known, since it had been observed in other lending markets, but one thing made things very different in this case... they also assumed that house prices couldn't go down!
Note that this scenario should have been stress tested, and dynamic correlations should have been assumed; but then again, who wants to see risk when leveraged positions allow for 25% annual return...
Almost, but not quite. Tranches actually refer to the level of defaults, not to individual cash flows. In other words, the first tranche gets taken out by the first group of people to default, regardless of which payment they default on. How do I know this? I worked on CDO pricing code about six months ago...
You're describing a position where you buy a call and a put at the same strike price. These are different derivatives, so they don't cancel each other out like the portfolio in my example. It's hard to make money buying a long call and put at the same strike price, because you're paying for two option premiums. The stock has to move a LOT in either direction for you to make money. If it doesn't move at all, you lose a ton on the premiums.