Wednesday, May 21, 2008 0 comments ++[ CLICK TO COMMENT ]++

Moody's Computer Bug Leads To AAA Ratings for CPDOs

News keep getting worse on the credit front, with Moody's being accused of assigning and maintaining AAA rating on CPDOs even after the discovery of computer errors. I vaguely touched on CPDOs in a prior post where I was arguing that mark-to-market losses don't necessarily mean anything. In any case, Financial Times is accusing Moody's of rigging their rating of CPDOs after discovering a computer bug in their rating model (story from Bloomberg).

Moody's Investors Service said it's conducting ``a thorough review'' of whether a computer error was responsible for assigning Aaa ratings to debt securities that later fell in value.

Some senior staff at Moody's were aware in early 2007 that constant proportion debt obligations, funds that used borrowed money to bet on credit-default swaps, should have been ranked four levels lower, the Financial Times said, citing internal Moody's documents. Moody's altered some assumptions to avoid having to assign lower grades after it corrected the error, the paper said.

The allegations raise questions about internal controls at credit ratings firms as they face scrutiny from lawmakers and regulators for assigning their top grades to securities derived from loans to people with poor credit.

The interesting thing is that S&P also gave AAA ratings initially, while DBRS and Fitch didn't, so the computer error really isn't as serious as it seems. It wasn't as if Moody's was placing a rating way out of line with the competition. However it does raise questions about quality control and tarnishes the reputation of the firm. There will also be accusations of cover-up, with the government likely investigating the matter well after the fact (as usual). They are already investing the rating agencies, bond insuers, brokers, and others, due to the subprime implosion but they will probably spend more resources now. None of the allegations have been proven.

It's a serious accusation and, needless to say, Moody's stock is down around 14%. It simply erased the run-up in the stock price over the last week or so, and Moody's stock didn't hit any all-time lows or anything.

In terms of market impact, it's likely to be minor (except for select areas such as the monoline bond insurers or other rating-sensitive businesses). My understanding is most of the CPDOs were sold in Europe and they were liquidated in the last few months (with big losses for investors).

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