Moody’s Corporation Bit By Computer Bug

Is is finally time for Warren Buffett to take Moody's (MCO-NYSE) over his knee and give it a good spanking? The stock has been recovering lost ground of late, but the nascent rally is likely to get snuffed out as one of the most embarrassing episode in the company's recent history comes to light:

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. FT

Good lord! This is the latest in a series of revelations that have rocked the ratings agency. Some people saw it coming, including short seller extraordinaire James Chanos of Kynikos Associates, who laid out his bearish theme last spring, but the latest revelations probably exceed even Chanos' imagination. Although he probably would not be surprised by the way it was handled:

On discovering the error early in 2007, Moody’s corrected the coding glitch and instituted methodology changes. One document seen by the FT says “the impact of our code issue after those improvements in the model is then reduced”. The products remained triple A until January this year when, amid general market declines, they were downgraded several notches.

Moody's responded in a press release; little solace to investors who held the constant proportion debt obligations; if they could not take the pain and decided to bail out they suffered losses in the 60% range.

“Moody’s regularly changes its analytical models and enhances its methodologies for a variety of reasons, including to reflect changing credit conditions and outlooks. In addition, Moody’s has adjusted its analytical models on the infrequent occasions that errors have been detected.

“However, it would be inconsistent with Moody’s analytical standards and company policies to change methodologies in an effort to mask errors. The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised about European CPDOs. We are therefore conducting a thorough review of this matter.”

Moody’s prodigious cash flow generation can now be put to a good use; paying severance to the people who screwed this up. But with rumors circulating of some sort of cover-up, this could turn into the biggest scandal since Watergate.

The stock spent several months basing in the mid-$30’s before its recent blast off, but if any significant legal liabilities arise, the stock could go right back to where was a few weeks ago. 

As Chanos said nearly a year ago:

Moody’s might face lawsuits for keeping its ratings of subprime loans too high.....Moody’s is ``integrated into the whole underwriting cycle of structured finance,’’ or bonds based on the repayment of mortgages and other loans.

``We believe they and the other rating agencies have been reticent to downgrade anything.’ 1440 Wall Street

Warren ownd roughly 19% of the company, and apparently is staying mum. But I believe, in many ways, this unfolding drama is worse than the Salomon Brothers Treasury Bidding scandal that Warren intervened in back in the early 1990’s. At least from a public relations standpoint. And the worst is yet to come.

Warren is busy enjoying his cult of celebrity on his World Tour, but it is time for him come home and roll up his sleeves.

But, untl he returns, Mr. Market will have to dole out the punishment.

First test of support --$42

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Moody’s error gave top ratings to debt products
Financial Times

A CPDO rating explainer
FT Alphaville

Chanos Lives for Contagion
1440 Wall Street
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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No Position

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