We discuss adjustments a lot on this blog. Today there’s a remarkable example and brewing scandal involving first a computer error in which Moody’s incorrectly graded certain debt obligations. The real story comes after the problem was identified – as it is alleged that Moody’s altered its models to avoid having to fully undress its error in public.
On May 21, 2008, Bloomberg reports:
May 21 (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.
I wonder whether they used principal components or multiple inverse regression.
The implications of that last paragraph are absolutely insane. “Some senior staff at Moody’s were aware in EARLY 2007 that CPDOs rated Aaa the previous year should have been ranked as many as FOUR LEVELS LOWER, the FT reported today, citing internal Moody’s documents. The firm ADJUSTED SOME ASSUMPTIONS TO AVOID having to assign lower grades, the paper said.”
First they make a mistake they shouldn’t have made. I mean, where were the checks and balances? Where were the reviews? Second, they then take that honest mistake and go criminal with it. Just brilliant. Amazing really.
Moody’s didn’t mention anything about not jousting with jesters.
Another financial blogger comments:
However, the implication that Moody’s had to fudge the numbers in order to come up with AAA on these deals but S&P came up with AAA with a “correct” model is something I for one am having a hard time with