Moody's Under Fire for Alleged Ratings Inflation

You knew this was coming. It’s one reason why I have yet to figure out why Buffett still owns any shares in this company.

I’ve written numerous times that the ratings agencies made mistakes on the ratings of all sorts of debt securities and their derivatives. Most of the mistakes were based on hubris. That is, the mathematicians had far too much confidence that their equations could handle any situation, only to find out that the models were ill-suited for the purpose which they were intended.

There were, however, some signs that fraud was sneaking into the picture. One example is where Moody’s (MCO) found an error in a computer program. The mistake caused certain debt securities to be rated far higher than they should have been. You’d have thought Moody’s would have issued a correction, but instead they changed the equation’s “volatility” input, which kept the ratings high. Basically, to keep the rating elevated, Moody’s said that the bond market would remain stable, with low volatility, for as long as the securities exist.

That’s bad enough. But late Tuesday night, The Wall Street Journal broke a story that paints an even more disturbing picture.

The analyst, Eric Kolchinsky, said Moody’s Investors Service gave a high rating to a complicated debt security in January 2009 knowing that it was planning to downgrade assets that backed the securities. Within months, the securities were put on review for a downgrade.

Wow. Read the whole thing. And remember, in a chicken/egg sort of way, it was the ratings that allowed the market for these securities to grow so explosively.

UPDATE 1: Former Moody’s Insider says firm “should be liquidated“.

UPDATE 2: Clusterstock is on fire with this story. A former insider (don’t know if it’s the one from Update 1 or not) explains the details of a “fraudulent deal”. Clusterstock also has the testimony a former Moody’s managing director will give to a regulatory body Thursday.

Comments

[john s. gordon:]

when the results don't match the desired results, you fudge the inputs.
this is the oldest game in benefit/cost analysis, of which i've done quite a bit.
> jack

Sep 24 08:40 AM

[nobby73:]

What do you mean, "desired results"? This is a ratings agency, there should not be a desired result, merely impartial and objective analysis.

On Sep 24 08:40 AM john s. gordon wrote:

> when the results don't match the desired results, you fudge the inputs.
>
> this is the oldest game in benefit/cost analysis, of which i've done
> quite a bit.

Sep 24 11:34 AM