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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.'"
Exactly because they need a reason why they rated securities backed by sub-prime negative amortizing loans at AAA. This in turn caused serious miscalculations of risk which led partially to the current economic downturn we are now facing.
The other part was that companies were all too willing to offer these risky products and buyers were all too willing to lie on their loan applications to get approved for them.
This is another example of how good news in the economic field can easily go unchecked because it is beneficial for everyone involved (in the short term) for the world to believe them.
My favorite, and perhaps the most drastic, example is how the US government grossly misrepresents employment stats, the consumer price index, and the GDP. This creates another bubble; not for the New Economy or for the housing market, but for the US as a nation. As long as people keep believing in the "world's strongest economy", investments pay off much as they do in a pyramid scheme - but the point where they won't becomes ever more dangerous the longer the scheme holds.
I for one prefer investments in Europe if only for the seemingly more reliable numbers they have there. Investing in the US is a way too dangerous gamble right now.
blow your mind already
Suuuuure... a coding bug is to blame! Nevermind that the agencies selling this financial toxic waste *paid* Moody's, S&P and others to provide good ratings. Software bug or no, there is fraud all around within the US economy--and no one was complaining as long as people at the top were raking in billions of dollars in profits.
This entry at Calculated Risk openly wonders if Moody's jiggered its model expressly so that it would line up with whatever the Standard&Poors ratings were.
Personally, I'm concerned this revelation will result in a concerted effort to blame the whole mess on a computer error, rather than the profoundly bad judgment exhibited by fund managers and investment banks. Expect some hapless programmer to be located and pilloried.
Schwab
Editor, A1-AAA AmeriCaptions
IOW, they are blaming the coders for generating results that should have
failed even the most basic sanity checking. All of their finance geeks
upon seeing these ratings should have been individually and collectively
scratching their heads.
I'm not sure I buy it really. It just seems like corporate blame deflection.
I dunno. I'm no MBA but I would imagine that the rating of any composite
security should be the lowest rating of the most risky component.
A Pirate and a Puritan look the same on a balance sheet.
failed even the most basic sanity checking. Indeed. This isn't a coding error, it's a testing error. Or perhaps a process design error.
Any professional knows that coding has a certain error rate. So you add practices, like pair programming, unit testing, acceptance testing, external code reviews, parallel implementation, and black-box testing until you get below the error rate you need.
For some part-time e-tailer's web site, you can skip a fair bit of that; if you fuck up badly enough, you might cost them an entire $500. But in the financial world, they know that errors can cost a lot more, like a million times more, and so it's worth spending more on quality-oriented practices.
Blaming this on the coder who happened to make the key error (if indeed their was one) is like blaming the Titanic disaster on some guy who missed a rivet on that side. It's the purest bullshit, designed to deflect responsibility from the people in charge. If they set it up right, a single person would be unable to make a mistake of this magnitude.
To the extent that different investments in a portfolio (which is what a "composite security" is, in essence, a prepackaged portfolio) have independent risks, there is a leveling effect (this is why, e.g., when you roll two dice, the distribution of the results is tighter proportionate to the range than when you roll one, and tighter still when you roll three, etc.)
OTOH, to the extent they tend to vary together, they don't level each other. Assessing the degree to which two different investments are independent in their risks is, AFAIK, still more art than science to start with, and when the people doing the assessment often have financial interests (even if only indirectly) in promoting the sales of the packaged investments, well, the results are likely to represent those interests more than any rational assessment of reality.
This entire story is bullocks, and your analysis is accurate. We aren't talking about a trivial error here. The models were spitting out obviously false results, and Moody's (and everyone else) gladly accepted those bad results. For at least 3+ years now, several analysts have pointed out ratings were too high and that they didn't pass the "smell test". If Moody's is not responsible for their models, then why shouldn't I write some half-assed model of my own, demonstrate to lenders how in the short term it will make them money, and then when I get caught, just point out that I never claimed my models were accurate.
Actually, that's not a bad idea.
To put it in a language slashdotters will understand.
1. Invent model.
2. Lie about model's accuracy.
3. (Sell model)???
4. Profit.