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.'"

Comments

not err

[Anonymous Coward]

Cue the onslaught of economists and generally math-illiterate people saying that computer models just can't be trusted. They can, ya morons, just not when they're implemented by penny-a-day visual basic dolts.

Re:not err

[Anonymous Coward]

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.

Re:not err

[jedidiah]

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.

Re:not err

[Hemogoblin]

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. That's not correct in general. Many structured products and derivatives have components that cancel each other out. A really silly example is a portfolio that buys a stock and short sells it at the same time, which will net out to nothing (except lost transaction fees). Obviously CDO's and whatever are ridiculously more complicated, but you get the point.

Re:not err

[Anonymous Coward]

It looks like the problem is that these investment vehicles are really hard to understand the intrinsics of, let alone model properly. The FT's awesome finance blog, FT Alphaville goes into a lot more depth on the whole issue - they "explain" the investment thingies themselves, the CPDOs, as well as the failures themselves.

"I'm not sure I buy it really. It just seems like corporate blame deflection."

If anything, the story paints a completely different, much worse picture:
1) Coding bug found to be cause, internally at Moody's
2) Internal docs show adjustment of model factors, ruling out high volatility as part of the model, in order that ratings after the bug fix don't deviate much from those before the bug was found.

That's my understanding of the story, anyway - IANAFinancier. But to me this paints Moody's in a much, much worse light than if they had *just* had a bug in the initial model which they then fixed - after all, that would have resulted in a re-rating...

(Again, I don't quite understand what's going on here, but that was my initial take on the situation)

Re:not err

[dubl-u]

IOW, they are blaming the coders for generating results that should have
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.

Re:not err

[DragonWriter]

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.

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.

Re:not err

[tqft]

Coder? More like junior messed up a spreadsheet and higher ups had no way to know if it was right or wrong other than the issuers who pay Moody's & S&P (and others) big time for ratings kept coming back for more.

Now if the users paid for ratings the customers would be whining pretty hard - to some extent the users of ratings do pay in deciding what effective interest rate they will pay to hold a bond.

Re:not err

[Alpha830RulZ]

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.

Nor are you a statistician (which I'm not either, BTW, but I slept in a Holiday Inn Express last night...). Not dissing you, BTW.

The risk of a portfolio is dependent on the individual components' correlation with each other, as well as their individual risk. You can make a fairly safe portfolio out of relatively risky investments, IF the individual investments are not correlated in their behavior. If you have stocks and bonds in your portfolio, for example, this reduces portfolio risk because prices of stocks and bonds tend to not track each other tightly. Something that trashes the stock market overall may not impact the bond market as much, thus the variability in the overall portfolio is reduced.

This assumption of lack of correlation is what is causing the house of cards to tumble. Risk packagers assumed that there would be no fundamental common fall to the subprime housing market, and priced risk accordingly, which caused interest rates to be too low for the associated risk, which caused over-purchase of the loans. Everyone could have been completely honest, and we would still have this problem.

From my limited understanding of the problem, there are several fun things going on in this situation, any one of which are troublesome:

1) the real estate bubble as a whole, where we lost sight of what a piece of property can really be worth. Regardless of how pretty the house is, the price has to be something that can be paid for out of the income stream of the owner. This was enabled by

2) the mispricing of loans by the industry, in part due the flawed risk assessment, and in part by the complete breakdown of law and morality in the mortgage brokering business, well described elsewhere. These two factors made it cheaper for marginal borrowers to get into property that they couldn't afford, and in that deal (this is subtle) the ultimate lendors endangered themselves because they made loans at an interest rate which did not properly compensate them for the risk they took on. This was enabled by

3) the growth of the securitization of the mortgages into portfolio securities. This was and is I think a good idea, as it allows flow of capital into housing loans from sources that wouldn't otherwise easily be able to supply it. However, apparently the risk modeling that was used to price these was flawed, well before the aforementioned bug surfaced. That meant that these loans were mispriced, as I mentioned before. Since the price was too low, people overpurchased the product. Several somebodies, somewhere, didn't factor in the risk of the bubble in the prices mentioned in one, and what a price collapse would do. That fundamental risk, and the resultant mispricing of the loans is what is bringing the house of cards down. That risk makes this bug trivial in comparison. IMCLTHO

Re:not err

[Z34107]

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.

Re:not err

[tomhudson]

after a computer coding error was corrected, their ratings should have been up to four HUNDREDnotches lower.

There. Fixed it for ya.

Seriously, they wilfully looked the other way. There is NO way that hundreds of these "new investment vehicles" could have been expected to receive AAA credit ratings when there are only a handful of corporations that have that rating.

This was a case of "don't ask, don't tell - because then the game is over". Everyone knew it was bogus, but nobody was going to be the first to blow the whistle - not when their continuing to make the big bucks depended on them not rocking the boat.

Re:not err

[lgw]

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. Yes, giving CDOs and MBSs AAA ratings just because house prices have never before declined sharply enough to affect the reliability of these securites was a problem, but government oversight wouldn't have helped here: securities regulation is good at preventing us from repeating past errors, but that's about it.

Of course the credit agencies used past data: that's how insurance works. You examine the past for hard data on the likelyhood of events, and the cost when those events occur. Stating a couple years ago (as I did) that house prices were in an unsustainable bubble (or as Shiller did much earlier) was just an opinion. Shiller is taken seriously *now*, because his hypothesis made predictions that turned out to be accurate, but before those predictions were validated it was just another hypothesis.

Would a government bureaucracy that ignored the prevailing opinions in a field and ruled based on one guy's untested hypothesis really be a good thing? Does "we need a government bureaucracy so that we can react to change quicker" make any kind of sense whatsoever?

The credit crunch happened because people willingly borrowed more than they could afford to. Asking for a government "department of preventing me from borrowing too much" because you don't have the sense to moderate your spending is a really pathetic abandonment of personal responsibility, right up there with a "department of outlawing unhealthy foods" because you don't have the sense to moderate your eating.

It's not the government's fault if you bought a house you couldn't afford. It's not the seller's fault. It's not the lender's fault. It's not the credit agencies' fault. It's not the evil corporations' fault. It's not George W Bush's fault. (And yes, I've heard every one of these arguments used seriously.)

Re:not err

[columbiatch]

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.

Re:not err

[lgw]

It's more complicated than simply reducing correlation. To hugely simplify: let's take 10 mortgages of equal size, and sell 2 securities related to them:

* The "senior" security is the size of 5 mortgages, and pays it's buyer as long as *any* 5 of the 10 mortgages are paid.

* The "junior" security is also the size of 5 mortgages, and assumes all the risk for all 10 unless 6 or more of them go unpaid (but pays a really nice interest rate).

How reliable is the senior security? If you look through all historical American data and see that failure of 60% of mortgages has never happened (assuming here that we're taking the mortgages from different markets in theis simple example) then you have created a security that, based on all available historical data, is quite reliable.

Of course, the reality of thse securities is far more complicated, but this gets the basic idea across: in order for the AAA rated securites to fail, we'd need a fall in house prices unprecedented in American history. A few of have been predicting such a fall for years, but so what? There are always some loonies predicting doom and gloom, and the hard data supported the ratings.

Re:not err

[electroniceric]

Therein lies the problem: the senior 100000 of 2 million piece of crap mortgages that their holders can't pay still has a high likelihood of some or all of those mortgages defaulting. So if the pool overall is no good, the seniority does nothing to solve that problem. And that's before CDO^2 nonsense is used to claim that the senior of lots of junior tranches of various pools are as good as the senior tranches of a single pool...

So the senior tranches of CDO's have to be based on the risk ratings on the whole mortgage pool, and this is precisely where Moody's and S&P bamboozled the public and are now trying to blame it on a bug. They would bless the claim that the top of nearly any pool was great stuff, no matter what the contents of the pool were. As others have observed, that's no coding bug, it's a policy to willfully ignore reality to facilitate the sale of more securities.

The mortgage market was hardly unserved when the securitizers entered it - rather it was full of banks offering conventional mortgages at rates that properly priced the risk (and the banks took care to do that, since they held on to the risk at that time, and federal insurance laws require them to have sane risk holdings). The introduction of securitized mortgage products flooded the market with much cheaper debt. That meant that the pools kept getting progressively worse and worse as the lenders headed down-market to try to sell mortgages to people who didn't already hold more than enough debt.

And as for the loonies, as asset bubbles go, the runup in housing has only one precedent in American history: the speculation before the Great Depression. Now there are a lot more safety valves in the finance system these days, but to claim that it is or was doom and gloom to be concerned about the size of the bubble is pretty a blinked view of the world.

Re:not err

[sjf]

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.

Nope. That's precisely the opposite purpose of a composite security. Think about a mutual fund: the risk of one component is mitigated by the risk of all the other components.
You'd have no possibility of retiring if your pension was predicated on the risk of your riskiest investment.

Re:not err

[Alpha830RulZ]

and the hard data supported the ratings.

Which is the fundamental issue here. The ratings, or rather, the underlying risk models depended on some assumptions about the data, that past trends will continue. In a bubble situation, which I think is how history will view the real estate situation, the trends are not reliable indicators. It's a black swan problem .

Re:not err

[TemporalBeing]

If you look through all historical American data and see that failure of 60% of mortgages has never happened (assuming here that we're taking the mortgages from different markets in theis simple example) then you have created a security that, based on all available historical data, is quite reliable.

You forgot about 1929, didn't you? There is prior precedence for such a fall. And the US housing market really sucked thereafter too until just after WWII at which point it picked up steam and stabilized until the late 1980's where it jumped and started the creation of a big bubble that is only just starting to deflate. There's a study out there of housing data from the late 1800's until pretty recently. (Wish I had the specific link, but you can find it on-line. It was done by Harvard/Standford/ or such.) The study adjusted for inflation and leveled, which set the adjusted housing price at $100k. During the Great Depression it dropped considerably (over 50%), and didn't revive until after WWII, when it came back up to around $100k and stayed there until the late 1980's when it started to go skyward, peaking near $190k or so around 2002 or so, and then starting to decline. I think the most recent number was still above $180k. Guess what? That number still has a long ways to drop before it'll be back in reality.

The problem is larger than simply what you are stating, though it certainly didn't help at all - and problem made things worse.

What you have to look at is the long term trend and also the affordability to the base market. For example, in Northern Virginia buying a house went skyward after 2000. My sister's townhouse went from $93k (1997) to a peak of $330k (2005) - little to no change in the property itself outside of standard maintenance. It's settled down some, but is still well above $200k. The primary causes were (a) zoning laws modified to "keep the way of life the same" (i.e. houses spread apart, country feel), (b) growing increase in population, and (c) the belief that the prices would forever go up b/c the gov't is there and thus makes a stable economy.

The problems ended up being: (a) there existed a $20k gap between what an individual could leave on under subsidized housing ($42k salary max) and what the same person could live on without subsidized housing (roughly $60k salary) due to housing (renting) prices alone, and (b) the base market (people in their mid-20's to early 30's) were being forced out of the market - they simply couldn't afford to buy a house any longer; moreover, it was showing signs of the problems even in 2005 when people that had been in the area for a while wouldn't have been able to buy their own homes.

I still have quite a few friends in that area, and while the market has come down some, it is still quite crazy and unaffordable (the reason my wife & I moved out of that area). Sadly, many are in a very tough position b/c if the housing market keeps going the way it is (and it will until it reaches a full correction) many are going to end up in bankruptcy as a result. But that's the "high demand" side of the story.

On the other hand, out in Columbus, OH - city officials decided they wanted to "clean-up downtown" and get rid of the "poor people", so they worked with lenders to get those people loans and move them out to the suburbs. For example, in my parents development there was a high school student who (a) just graduated high school, and (b) didn't have a job (period!) but had been qualified for a mortgage and allowed to buy a home. She's now in bankruptcy. The "clean-up" simply put the poor people elsewhere, essentially making them someone else's problem while making the politicians look good. In the meantime, that "someone else's problem" has resulted in mass foreclosures in neighborhoods as things caught up to people that weren't have been able to pay the mortgage to start with and ended up in foreclosures quite predictably, which is on

Re:not err

[WaZiX]

This assumption of lack of correlation is what is causing the house of cards to tumble. Risk packagers assumed that there would be no fundamental common fall to the subprime housing market, and priced risk accordingly, which caused interest rates to be too low for the associated risk, which caused over-purchase of the loans. Everyone could have been completely honest, and we would still have this problem. They didn't assume lack of correlation, they assumed low correlation is calculated on historical data, and historically, loans were not given to subprime borrowers. As they gave out more and more loans, the marginal quality of the loans decreases, increasing the risk of the loans, but more importantly, increased the correlation between defaults.

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...

Re:not err

[Anonymous Coward]

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...

Re:not err

[Hemogoblin]

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.

A Moody Bug?

[SIR_Taco]

Great... sounds like my girlfriend

Likely a feature

[bartle]

This doesn't explain how Standard and Poor's arrived at the same ratings. One possible explanation is that Moody's code was initially correct but they introduced the "bug" to make sure they were providing the same valuations as S&P.

In any case, it sounds like they found a new scapegoat and they're going to take it for a test ride.

Re:Likely a feature

[Bryansix]

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.

Re:Likely a feature

[dal20402]

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.

Re:Likely a feature

[ztransform]

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.

Re:Likely a feature

[Zeinfeld]

Looks like the corporate equivalent of 'the dog ate my homework'.

So perhaps they could explain why municipal bonds have much lower default rates than equivalently rated commercial paper and this has been the case for several decades? Is this also a computer bug? I suspect not, I think they rate the commercial paper higher because they pay for the ratings.

So where is the accountability here? Do people who relied on these faulty (or fraudulent) ratings get to sue? If not, why did they ever trust a rating that nobody can be held accountable for?

Re:Likely a feature

[Belial6]

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.

Re:Likely a feature

[ejecta]

I'm one of those people who got fired for not forging documents.

Apparently I was meant to be okay with plugging someone earning $2,000 a month into a mortgage that would cost him $4,000 month. He had $6,000 savings. Simple maths indicates he'd be against the wall in 3 or less months - but they simpled fired me, and then submitted the loan application in my name.

Thankfully I was smart enough to email myself all the emails on such topics before I was escorted out of the office - so should I ever get a visit from the boys in blue I can simply pass on the evidence and they can go sweat someone else.

Re:Likely a feature

[Aardpig]

Except that all lenders are required to provide a Truth in Lending statement, and comply with it. If they misled the borrower, then they have broken the law; there's no two ways about it.

Re:Likely a feature

[Anonymous Coward]

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

Re:Likely a feature

[scheme]

I don't understand how the lenders tanked so quickly, since they were selling the loans as securities immediately after closing the deal. Can anyone shine a light on this for me? For instance, why is Countrywide up a creek, if they weren't left holding the bag? It would seem to me that Pension funds are where the real sh*tstorm would be, but that doesn't seem to be the case.

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.

Re:Likely a feature

[klenwell]

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.

Re:Likely a feature

[Belial6]

The only thing that saved my wife was that she was incredibly productive. When she would run across something they wanted forged, she would send them an email to the effect of "I am unsure of the legality of doing this, so if you can just send me back an email letting me know it is legal, I will complete the task. Thanks." This would result in a request to have the documents delivered to the managers office, and that would be the last she heard of them. If she wasn't out producing most of the other funders 2 to 1, she would not have lasted a month. In the end though, she did get fired for it at the first job. The second job ended because of the crash. They actually seemed to be OK with her refusals. They just let her crank out her work, and handed anything shady to someone who might be slower, but could prove their worth by handling such "problems".

The best part is that when we counted up the costs of daycare, gas, clothes, taxes, etc..., we only lost $400 a month when she wasn't working. It never made sense for her to go back to work.

Re:Likely a feature

[Dachannien]

banking coders tend to be rather cowboy-ish That's because they're always programming in COWBOL.

*rimshot*

Thanks, I'll be here all week.

Re:Likely a feature

[ejecta]

I did the ole "You're telling me to say he's earning X yet we can only demonstrate Y, can you please send on the documentation regarding Z".

They forwarded my termination papers inside. Which is bizarre in itself seeing as I was the only person accredited by the lenders to sign off on loan applications - but I guess that's no hinderence when they are happy to put my sign off on things I've never approved when I'm no longer there.

I'm not that worried though, whilst it sucks supporting a family of four on no income (wifes a stay at home mum) I'd prefer to be looking for work than constantly having to cover my ass and wondering if the next day is the day the feds are coming to come through the door.

Also helped I hadn't taken a holiday the entire time I worked there and they had to pay out 8 weeks leave + 4 weeks termination pay.

Re:Likely a feature

[blincoln]

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.

Re:Likely a feature

[gambolt]

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.

Re:Likely a feature

[ThaReetLad]

I have only one thing to say to you and your wife. I hope you do go to jail. I know technically you did nothing wrong, but you failed to blow the whistle on illegal practices which have helped to propel the world into financial chaos.

People losing their homes is as much on your heads as if your wife HAD forged those applications.

Yeah right, that's what it was...

[Colin Smith]

A coding error.

Re:Yeah right, that's what it was...

[PotatoFarmer]

while (true) {
if (isSECWatching = false) {
commitEgregiousFraud();
}}


Assignment vs. equality check strikes again!

unlikely

[blackcoot]

this is probably more a feature than a bug --- those instruments are rated by multiple agencies, each of which use their own risk evaluation methodologies and software. i find it highly unlikely that s&p would make mistakes, independently, that would cause it to give the same junk paper the same AAA rating that moody's gave.

Re:unlikely

[ejecta]

Fitch, S&P and Moodys often have very similiar ratings. It's as if one goes first and the others follow so they don't have to answer questions about having a largely different rating.

Plus, if you rate someone poorly they may not pay you to rate them again. One of the lenders I worked for had the option to use S&P or Fitch, they got a poor rating from Fitch one year and used S&P ever since - that's a heck of a lot of cash not going to Fitch anymore.

Good economy news go unchecked

[Denial93]

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.

Re:Good economy news go unchecked

[Jeff DeMaagd]

Regarding the shadow stats site, I'm wary of the type of conspiracy proponent that tries to push a product, book or service. Especially for this, non-subscribers wouldn't be able to pick apart the results. In the same way, this is why I don't like the articles based on what financial analysts say, because you have to buy the original report in order to make sure they aren't pulling any shenanigans.

Re:Good economy news go unchecked

[nido]

This is how the author makes his living - everyone has to support themselves somehow, you know. If he gave his insights away for free, he wouldn't have nearly as much time to devote to his specialty as he does.

I wrote a diary on k5 a few years back which referenced Shadow Stats, which linked to an interview that links to a fuller interview of John Williams, the guy behind the Shadow Stats site.

My impression is that while Mr. Williams is quite right about the government mangling the statistics, he's wrong about the long-term implications (inflation forevermore). I like Mish of the Global Economic Analysis blog's take: he's been saying for some time that the end-game of current economic developments is massive deflation, as all the loans in the economy go bad one at a time, in a sort of cascading system failure. We're now seeing the deflation prediction come to pass - while Gas & food are skyrocketing, other assets (housing, etc) and prices are dropping fast, as homeowners and businesses struggle to find buyers at any price. This is what you'd expect if the amount of money available in the economy (read: available for the everyday working Joe to spend - the trust fund manager who made $1billion last year doesn't count) was decreasing.

For the record, I don't subscribe to Mr. Williams' newsletter - much too poor for that right now.

Re:Good economy news go unchecked

[Tycho]

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.

Bullshit

[Anonymous Coward]

Total B.S. The ratings were wrong because various companies needed these AAA rating to stay in business. (And if you need a AAA rating to stay in business, you don't deserve a AAA rating.)

A bug management knew about for 2 years..

[WarwickRyan]

..isn't a bug, it's a feature. Of fraudlent behaviour from management.

Re:A bug management knew about for 2 years..

[kcelery]

The question remains, does the 'CDO coding error' ends there? How faulty are the bonds and commodities ratings?

After the OpenSSL bug

[Ckwop]

... and this bug.. is it not time we started acting like engineers and started building software in a way where we can show it is correct.

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

Re:After the OpenSSL bug

[nomadic]

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.

This is Slashdot, where everyone just blames management. Because you know, there are no incompetent programmers in existence.

Re:After the OpenSSL bug

[vux984]

... and this bug.. is it not time we started acting like engineers and started building software in a way where we can show it is correct.

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.

Lock it all up tight, and make sure every line of code being executed is signed and certified.

And given how difficult it is to right correct code, I'm not sure a 'formal verification' would be worth that much. I mean, you think Windows is expensive NOW?

Not sure OSS could even exist in a world like that. After all, 'formal verification' isn't free. And you wouldn't be allowed to modify your own source... the liability issues alone!

Be careful what you wish for.

Re:After the OpenSSL bug

[Rakishi]

... and this bug.. is it not time we started acting like engineers and started building software in a way where we can show it is correct. Well enjoy paying $200k per copy of MS Office, personally I'll take some bugs instead.

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. Last I checked mathematicians can't even say if my program will finish running much less if it will work as advertised.

Re:After the OpenSSL bug

[blahplusplus]

"we really need to start growing up and using the tools the mathematicians have provided us"

Mathematicians are only part of the answer unfortunately, there needs to be standardization in functions and code, so coders do not have to rewrite the wheel.

I've been thinking a bout making a completely visual compiler where you should not have to code in abstract numerics and other function statements beyond construction, all mathematical statemetns and programming statements can be virtiualized and rendered into a virtual 3D environment, and represented in a flowchart like format but much more like a diagram of an electric circuit and with things like what the size of X is and it's computational *load* on the cpu and whatnot.

Software engineering tools are really really bad, what really needs to be done is taking the math and expressing it as geometry in standardized ways IMHO so that you can actually *engineer* stuff, virtual structures and visual shapes and understand and visualize what the hell you are actually coding so that you can see the mistakes in the structure visually, since visualization is very very powerful and highly underutilized in software engineering,

I may have not described my ideas very well but hopefully those reading my posts get the idea, that software engineering has a lot in common with circuit design and should borrow and modify principles and concepts from hardware side in terms of expressing their programming and math in a format akin to electricity flowing through a circuit, etc.

Re:After the OpenSSL bug

[Gospodin]

And given how difficult it is to right correct code...

No kidding! Look how difficult it is to "right" correct English!

Re:After the OpenSSL bug

[Rich0]

software engineering has a lot in common with circuit design and should borrow and modify principles and concepts from hardware side in terms of expressing their programming and math in a format akin to electricity flowing through a circuit

Ironically the hardware side has been going in the opposite direction. How many transistors in a modern dual-core processor do you think were actually put there by hand with manual checking of voltage/resistance/heat/etc? Somebody writes up some code essentially and a program creates millions of gates to do what the algorithm dictates.

The problem with this visual rendering of software you suggest is that any non-trivial program is going to turn into a monstrosity of flow charts that would probably require tens of thousands of pages to print on paper. A single line of code could potentially be a few different boxes in a language like C.

The reason software engineering isn't like civil engineering is that while a bridge has maybe a few tens of thousands of parts, a computer program has the equivalent of hundreds of millions of parts (if you were to express the software as the equivalent machine). The best you can do is at least develop libraries that can have some level of specifications and testing around them so that you minimize the amount of code that is unique to a particular application. Software is just a different kettle of fish...

Re:After the OpenSSL bug

[Repton]

Not sure OSS could even exist in a world like that. After all, 'formal verification' isn't free. And you wouldn't be allowed to modify your own source... the liability issues alone!

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.

Re:After the OpenSSL bug

[smellotron]

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.

Re:After the OpenSSL bug

[vux984]

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.

Well the mind-numbing tedium for one thing. :)
But the real issue isn't lack of volunteers, its that volunteers are just as likely to turn in bad proofs as they are to turn in bad code.

If you wanted to build a bridge and some volunteer on the internet submitted a design, along with some structural analysis by other volunteers from the internet declaring that it was a sound design, would you just accept it and build the bridge? Or would you want some "officially sanctioned engineers" to review it first?

The issue with requiring that code be provably correct is the same; the proofs have to be done by people that are demonstrably competent at formal methods, and the proofs themselves must be reviewed by people who are demonstrably competent at formal methods. So even if the internet volunteers perform verification using formal methods -- no one will have any confidence that it was done right.

And of course, the number of volunteers capable of proving code (who understand the mathematics and what not behind the methods) and who interested in doing so is VASTLY outstripped by the number of volunteers capable and interested in writing code.

So even if the volunteers COULD satisfy the formal verification requirement -- OSS would be utterly hamstrung due to the back log getting new code volunteer verified.

Re:After the OpenSSL bug

[Garse Janacek]

But the real issue isn't lack of volunteers, its that volunteers are just as likely to turn in bad proofs as they are to turn in bad code.

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...

Lying Through Their Teeth

[littlewink]

The corrupt bastards are going to "shoot the programmer" on this one?

I want a federal investigation.

monetary incentive to inflate ratings

[nickhart]

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.

Re:monetary incentive to inflate ratings

[spun]

Damn it, it can be so hard to count your money with one hand while covering your ass with the other. Sort of like talking out of both sides of your mouth, it takes practice.

Calculated Risk

[ewhac]

Disclaimer: I am nothing more than a happy reader of the site.

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

wouldn't someone notice?

[belmolis]

If the errors are as large as it seems they were, wouldn't one or more human analysts notice? When your software says "Buy SCO" you should know that something is wrong.

Blame it on the programmers

[Whuffo]

Moody's were a part of the substandard financing disaster that's led to the current (arguable) recession. Rather than face the music for their (maybe fraudulent) misrepresentations they decided to blame it on "a coding error".

They're depending on us believing their media stories to escape responsibility; anyone who thinks about this situation would quickly realize that for a company full of financial analysts to not realize that an error of this magnitude was happening - well, it beggars the imagination.

What almost certainly happened is that they played the same game that so many other financial institutions did during the real estate bubble. But when the bills came due, they chose to deny responsibility and pass the blame on to someone else. The real crime here is that they'll be allowed to get away with this...

Better cite/site

[conlaw]

If you want to read the whole FA without paying for it, there's a good writeup at Bloomberg: http://www.bloomberg.com/apps/news?pid=20601087&sid=aA57lFH5Exj4&refer=home In it the Moody's folks explained that they "adjusted their analytical models" so that they didn't have to downgrade these instruments. But we're not to worry that they did anything wrong. In their words, they:

adjusted [their] analytical models on the infrequent occasions that errors have been detected,'' the[ir] statement said. ``It would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors.,.

You Gotta Be Joking

[HangingChad]

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.

Re:You Gotta Be Joking

[freedom_india]

How about the time when a 'mistake' lets me withdraw 1 million from an account which the banker thought was mine, even though i objected it was not?
Can i claim the same defense and escape the noose?
NO!!
The FBI will prosecute me for Mail Fraud and 37 other charges even though it was the banks' fault in forcing me to withdraw money from someone's account.
Moody's explanation is like a child giving an explanation for spilt orange juice on the carpet: The bottle was heavy.
Moody's execs should be prosecuted for mail fraud and sentenced, plus the judge should throw this fraud explanation back to their faces and seize their Social Security amounts.

Not the whole story

[analog_line]

According to one of the Financial Times reporters on the story, interviewed on my local NPR station, the rating was unchanged AFTER Moody's supposedly found and corrected the error, because they "changed their methodology" between the original flawed rating, and the discovery of the flaw.

This guy didn't sound especially convinced, and no one's mentioned any kind of due diligence requirement on the rating agency to actually make sure that their ratings are correct. Apparently whatever gets spit out of the formula is accepted as official, and in this case, they had a lot of incentive to fail to get around to any due dilligence.

Yep

[Sycraft-fu]

You can already buy systems like this. You can buy systems that absolutely have to work all the time, no downtime, no crashes, etc. However, there are some major stipulations:

1) It isn't cheap. There is going to me some major engineering to design it, and it will require some major redundancy in hardware to protect against faults. As such, you are going to pay a lot for it.

2) It isn't fast. No you can't have it today, you can't have it this month, you can't have it this year even. The development and testing will take a long time. This can't be rushed, it simply takes lots of time and lots of testing to make sure there are no faults.

3) You can't add features to it. Once the system is in place, it can run only what it was designed for. You can't go and install new software or anything. If you want any changes made, those will have to go through a full set of testing. No unverified code can be running.

4) It must be accessed only in approved ways. You can't just hook it up to the Internet and go wild, input will need to be properly regulated to make sure it doesn't cause an unforeseen problem.

5) You can't mess with it. Your people will not be screwing around trying things with it. It'll be maintained under a support contract only by certified personnel.

If that's not ok with you, well then some bugs are something you have to accept. This idea that programmers should be able to easily engineer perfect, bug free software quickly and cheaply is just amazingly ignorant. Especially when people come up with false analogies "Oh well people would sue if cars were made as badly as computers!" No, you'd get arrested (or killed) if you tried to use a car like people use computers. If people treated cars like computers they'd expect to be able to run in to a wall at 80 miles an hour and suffer no injuries to themselves or the car.

Cars work well if an ONLY if they are operated properly (and even then not always). You have to do things like obey proper driving regulations, maintain the engine, and so on. If you don't, well shit is going to go wrong, maybe catastrophically wrong. Yet people do just that with their computers all the time. They install random shit, never perform any maintenance, and expect that the computer will magically protect them from all problems.

Moreover...

[mpapet]

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.

It can't be Coders complaining

[cps42]

Any dev worth his salt would be blaming, in order:
1) The Firewall
2) The Load Balancer
3) The Firewall
4) The Network Routers
5) The Firewall
6) The Network Cables
7) The Firewall
8) The Network Engineering Team
long before they figured out it was a Layer 8 issue in the code.

Likely S&P cheating

[Scareduck]

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.

Billions of...

[dave562]

The wording of the summary is confusing. Were there literally billions of bonds given incorrect AAA ratings, or were the incorrectly rated bonds worth billions of dollars because of the flawed rating?

Confusing summary aside, this is the biggest load of crap I've read in a long time. The financial world made a really bad guess on just how much "money" was really in the US economy and now they are paying for it. They can't actually be held accountable because then people might catch a glimpse of the fact that the financial wizards who run our lives are really full of shit. So instead of taking responsibility for their mistakes they are blaming it on a computer bug. How effin convienent for them.

"Hey everybody, we aren't fucking idiots. You see, it was the computer! I just told you what it told me on my screen. Hold on... my third trophy wife is on the phone... she's telling me that her and the Lamborghini are stuck in traffic somewhere between my multi-multi million dollar home and the club house where I spend multiple tens of thousands of dollars a year. I'll get back to you right after I blow a few more rails of coke!"

How the hell did these people get to be in charge of society?

Re:Billions of...

[Magada]

Well, for one thing, the _rest_ of society is made up of simpletons whose mantra is "I want to believe."
Everyone in the US (and a few other places such as France and the UK) wanted to believe that they could buy expensive houses and flip them in a month or three, that the price of housing outside of big towns will continue to grow indefinitely (which is idiotic, in a world where there is a finite amount of oil), that everyone will keep paying their loans...
All this, because the alternative is believing in a resource-limited world which gets poorer in real terms (available energy, available raw materials, arable land) by the minute - a world not conducive to peace of mind.

Re:Billions of...

[dave562]

Well, for one thing, the _rest_ of society is made up of simpletons whose mantra is "I want to believe."

I completely agree with this. People don't want to be bothered with the reality of things. They don't want to take responsibility for themselves. They want to follow the herd and believe that everything will be okay because they are going along with what everyone else is doing.

I almost caved in. I almost bought some property at the peak but I realized that things were screwed up. I realized that real estate values were inflated. The thing that boggled my mind and messed me up is that I thought I was poor. I thought I was some how out of sync. "Everyone" around me seemed to be able to come up with some money for some property. The questions I was asking myself were, "Is there really so much money in the economy?" "What kind of jobs are these people doing that they can afford these housing prices?" "Where are all of the jobs that are letting people buy these houses?" In the end it looks like I dodged the bullet... kind of. The hidden tax of inflation is already here and it's only going to get worse. The Federal Reserve and the government are going to bail out all of the assholes. They have to keep "the economy" going. We don't produce anything in America anymore and we're running out of shit to sell each other. All we have is debt. I heard a rumor that they're going to collaterialize car debt. That's what it is coming down to... the wealth of our nation is based on our ability to reliably pay off our automobiles?!??

I call BS.

[benhattman]

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.

Re:not err -- Interesting Fed Paper

[Anonymous Coward]

Read the last two paragraphs of this paper (p26). It states that the credit ratings shouldn't have been relied on for certain types of CDO's because they had hidden risk that wasn't obvious.
The interesting part... the paper was written in 2004.
http://www.federalreserve.gov/Pubs/feds/2004/200436/200436pap.pdf

Another me-too post (please don't mod down)

[sydbarrett74]

I hate me-too posts, but I'm going to cast my vote in agreement that the explanation is too simple. This stinks of scapegoating.

Re:Another me-too post (please don't mod down)

[Kevin Stevens]

I agree, perhaps I can make a convincing argument as to why though.

They have changed their story. Their first story was a lot better. The fact that they are now changing their story makes me and I am sure the SEC call their bluff.

Anyway, their first explanation (revealed in a multi-page NYTimes article) was that the data supplied by the mortgage lenders was wrong. And this makes some sense- For years the model worked like this: Loan officers went and made loans, verified income, assets, their credit rating, etc. and made sure that the borrower could afford the loan. The interest charged depended on which tier of credit healthiness they were put into, and these loans were later resold to banks. The banks would package these up in a group and ship them off to Moody's and Fitch, who would then give them a credit score to say how likely each package was to default. A higher default rate would mean that a buyer would demand a higher interest rate return. What Moody's essentially did at this point was take the Loan Officer data and rate the tier of loans based on macro conditions in the market (general direction of the real estate market, rate of defaults by the tiers of borrowers, etc.) Their story is that they took the Loan Officers' word that these mortgages were affordable to the people they made the loans to, and this was not true. I can *kind of* understand this to a point, for years this is how the system worked, and it worked well, so I can understand that a slip in their standards would go unnoticed for awhile. However, there was signs all over the F'ing place that things were seriously wrong. "Option Arms" aka negative amortization loans (you owe *more* money after each month, not less) were used all over the place, incomes didn't even begin to match up with what these people owed each month.

To use the car analogy, imagine you were getting cars from Honda for years, and they worked as expected. If Honda started to cut corners here and there, you might not notice for awhile. But the drop in quality in the mortgage borrowers would be akin to Honda dropping off cars that were billowing out white smoke as you drove them off the lot. You would have to have your head in the sand and screaming lalala I can't hear you to not notice that something was wrong. At what point these companies switched from being duped to negligent is subjective, and that is what will be hotly contested in the months to come.

As an aside, lets talk about who these brokers are that were making these loans. I graduated in 2002, in more or less the trough of the downturn, at least from a hiring perspective. Yet a lot of the lets say, "not so academic" people I knew, the comm and psych majors were all getting hired at mortgage companies, which astounded me because many of them had no idea what an interest rate even was, let alone knew how to calculate a payment from one. But they went through a week long training course, put on a suit and tie or some stilettos and a skirt, and started calling people, pushing products they didn't understand, using the pitch script they were handed in training. And it worked, I was insanely jealous that some of these, pardon my french, dumbass jocks, were making 90k a year out of school while I was making less than half that putting in crazy hours at an entry level programming job. Some of them figured out what was going on, but they were so drunk on the money that they didn't care anymore.

As a final point, lets talk about the "coding errors." I have no inside knowledge, but I work in the industry, and I am pretty sure what they mean is that the models they use to predict the expected returns (which are all written in code these days) had a problem, and the code was probably entirely to spec but the spec was wrong. Of course it is much easier to spin it as a "bug" that some "programmer" made, rather than admit that the very core of their business was based on flawed assumptions. These models are tested extensively in any halfway decently run group, and usually run through a vigorous set of what-if scenarios to see how likely it is they would lose value.

Classic Prisoner's Dilemma at work... twice

[Anonymous Coward]

This looks as a Prisoner's Dilemma problem, and happened twice:

S&P first publishes the ratings and (maybe?) senior staff at Moody's don't stick to their guns when their own models didn't agree with S&P. Given that institutions are pushing hard for those credit derivative products, Moody's yields to pressure. The only game outcome that makes everyone look good is to give AAA's away together, despite common sense, otherwise they risk breeding a credibility crisis throughout the ratings industry.

Then the market comes down. Both S&P and Moody's are pressured to defend their credibility, but they do so in different ways: Moody's acknowledges the error, but it causes them to look bad, as S&P still insists their models are good (despite all the evidence to the contrary). The only outcome that makes everyone look good is either to acknowledge the error or defend it together.

And now, because no one defends their own position, the public will demand regulation of the industry, but the topic itself is so abstract (after all, all you're selling is an expectation of a certain outcome - i.e. "default" vs. "not default" - which one cannot truly guarantee if their life depended on it) that any regulation, by default, cannot be effective here. It's like demanding regulation of weather forecasts. There are quality parameters but, ultimately, how should the government punish a forecaster if he said it would rain but actually it was a sunny day?

Maybe the only fact is that the structure and governing logic behind commercially-sold ratings is just broke. There are so many vested interests that it's nearly impossible to be impartial.

Follow the money...

[morkk]

... from the lenders to the credit-ratings agencies.

Yes folks, it was the purveyors of the toxic-waste that *purchased* the ratings rather than the consumers - so naturally the ratings were good, bug or no bug.

There were other lesser known agencies at the time rating the same shite at 4 points lower, but then they were rating it for buyers, not sellers.

See here for more.

One thing I don't understand

[johannesg]

All of you guys that are now boasting here that you actually knew what was going wrong, but not one of you decided to open your mouth before it became a major disaster. Apparently the fact that the world economy has gone to shit over this means nothing to you, or the fact that thousands upon thousands are now homeless.

What I read here are admissions of guilt: you knew of a very serious crime with very serious consequences (and helped commit those crimes sa well) and chose to remain silent. It is both stupid (to admit to it now) and pathetic.

Re:One thing I don't understand

[ejecta]

Again, what exactly is "raise the alarm"?

Secondly, as I already said, things going to shit had VERY LITTLE to do with this type of fraudulent loan. Especially considering our (Australia) economy is still rock solid & growing rapidly despite such issues.

So again, what options existed to raise the alarm? You think a newspaper honestly would run a story about someone no one cares about?

At the end of the day regulation failed as all parties were interested in gaming the system - compliance & auditing works on the basis that Party 1 and Party 2 have different interests, when Party 1 & Party 2 have the same goal compliance & audit measures fail.

And seeing as you didn't catch it the first few times, I didn't stand by and do nothing - I put down barriers as well as protecting myself - I didn't just accept orders and sign off on junk loans.

Tranche is just the french word for "slice"

[Viol8]

But it sounds so much cooler saying "tranche" because then people arn't 100% sure what it really means. Its designed to obfuscate to people not in the know like a lot of the financial system.

Re:Tranche is just the french word for "slice"

[Abcd1234]

Meh, that's typical of every specialized industry I know of. Law, medicine, computing, engineering, you name it. They all develop a specialized lingo that identifies the players from the outsiders. Pretty standard human behaviour, really... kinda reminds me of the old days of the guild.