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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.'"
In any case, it sounds like they found a new scapegoat and they're going to take it for a test ride.
As an industry, we really need to start growing up and using the tools the mathematicians have provided us, just as other engineers do in other disciplines, to show our programs actually work as advertised.
The competent have nothing to fear from formal verification and anyone who is not capable of doing such verification should not be writing software anyway.
Simon
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.
So one of the top financial services companies in the world, staffed with MBA's and finance professionals, and none of them noticed a coding error that changed debt ratings by that big of a margin? That strains credibility to the breaking point. And on the other side of the table, none of the financial institutions buying collateralized debt instruments ever looked at those ratings and thought they were a little optimistic? Come on. The entire sub-prime mortgage mess was a computer glitch.
Guess that means cocaine use is alive and well on Wall Street. Because you have to be really, really high to field a whopper like that.
That's our life, the big wheel of shit. - The Fat Man, Blue Tango Salvage
They won't go after some low-profile wonk. The French bank with billions of losses from a couple of months ago is trying the same thing. It's not plausible.
This is very quickly how the scam works:
The way bond agencies survive is by acquiring new business. Let's say a utility issues a bond for a new water project. They shop the issuance around. Highest rating gets the business. The higher rating means (roughly) less "insurance" they have to carry and the more they can use free cash to do other things.
The bond agencies are as "financialized" as a low-end broker sweat shop. No one seemed to care when the money was flowing. It's easy to take shots after the fact.
Few people follow the Fed's TAF's and its junk-filled balance sheet. It's worse than the credit agencies situation. Who knows if that will ever blow up like the credit markets.
http://www.maxineudall.com/2010/02/should-economists-be-sued-for-malpractice.html
Calculated Risk believes this is a case where S&P decided not to believe their own models and tweaked them to match the results derived by Moody's, which spit out the wrong results in the first place. Call it bug-compatibility, but it's also clear that there were plenty of financial incentives at the time for the rating agencies to deliver results in step with their peers lest they lose out on lucrative "second opinion" business.
Dog is my co-pilot.
These structured products are broken into what are known as tranches.
Even if you know you're holding a pile of dog crap mortgages, you know that most will be able to make first months payment. Each successive monthly payment pool is likely to have more defaults, and thus uncertainty grows. If you take 1000 loans, and group the payments together, you can theoretically predict the risk of each band of payments. If you buy the first band, aka tranch, you're far more likely to get paid than if you buy the junior tranches that are expecting payments 30 years from now.
Here's where the fun stuff happens. Those earlier tranches that are more likely to get paid will usually be given very high credit ratings, as it's likely that the owner will collect the income from the pooled debtors. Since the security their holdings is so highly rated, perhaps AAA, then other institutions are willing to accept that AAA security as collateral for additional borrowing. This all continues on in a crazy cycle of leveraging until you have hunders of dollars of leverage to cents of actual income. All the while, these leverage products maintain a high credit rating, because it's all based off of AAA securities.
What happens when people start to default on the orignal loans and the person who bought that orignal pools of loans doesn't get paid? They can't pay their interest to a person who in turn can't pay their interest to a person who gets screwed and has to bring this "safe" security onto their balance sheet and write it all off as a loss. TADA! Credit crunch.