Computer error at Moody's assigns high ratings to risky debt

22 May 2008

Shares of rating agency Moody's Corp. were down 13 per cent, the most in nine years since it became an independent entity, on Wednesday morning in the wake of a Financial Times report alleging a computer coding error boosted the investment ratings of a particular class of debt instrument and wasn't immediately corrected after it was uncovered.

Some senior staff at Moody's Investors Service were aware in early 2007 that constant proportion debt obligations (CPDOs), funds that used borrowed money to bet on credit-default swaps, should have been ranked as much as four levels lower, the paper said, citing internal Moody's documents. Instead, they had been assigned Triple-A or ''AAA'' ratings. Which remained until January 2008, when market turmoil led to hefty downgrades.

These allegations couldn't have come at a worse time. They will raise additional questions about internal controls at credit ratings firms even as they face scrutiny from lawmakers and regulators for assigning their top grades to securities derived from loans to people with poor credit.

Ratings agencies such as Moody's, Standard & Poor's and Fitch have come under fire during the credit storm after triple-A rated debt instruments that contained sub-prime mortgages and other risky debt collapsed, further precipitating the crisis.

The crisis caused banks including UBS AG and ABN Amro Holding NV to unwind their CPDOs, triggering losses of as much as 90 per cent for investors. Total losses from deteriorating sub-prime mortgage and repackaged debt are estimated to have crossed $400 billion.

US Senate Banking Committee Chairman Christopher Dodd has flagged the potential conflict of interest between ratings firms and the issuers that pay their fees, while the Securities and Exchange Commission is probing the way ratings are assigned.