Wednesday, May 21, 2008

Moody's Blues

Credit ratings play a crucial role in financial markets, providing a system of classifying assets by their riskiness. In many cases, funds limit the type of assets they can hold based on their debt ratings, and the ratings are a major determinant of the market value of assets (even the Fed uses them to determine what assets it will accept as collateral for loans). Three companies - Fitch, Moody's and Standard & Poor's - dominate the market for rating assets. These rating agencies have come in for quite a bit of criticism as the recent problems in financial markets have made some of their ratings seem too generous in retrospect. And now this, from today's Financial Times:
Moody’s awarded incorrect triple-A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models, a Financial Times investigation has discovered.

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.

News of the coding error comes as ratings agencies are under pressure from regulators and governments, who see failings in the rating of complex structured debt as an integral part of the financial crisis. While coding errors do occur there is no record of one being so significant.

Moody’s said it was “conducting a thorough review” of the rating of the constant proportion debt obligations – derivative instruments conceived at the height of the credit bubble that appeared to promise investors very high returns with little risk. Moody’s is also reviewing what disclosure of the error was made.

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