Let's just get to it, okay?
I knew that Moody's was working hand in hand with financial houses to hoodwink investors. While for the most part basic due diligence should have made institutional investors very wary of a lot of the exotic financial instruments created in the Ruben Era, there was a lot of wholescale fraud as well.
I made popcorn because I knew one day, one day, my friends, I would be validated.
Today is that day.
Tucked deep within the SEC filings of Moody's, the supposed best ratings agency ever, was a bombshell.
http://www.sec.gov/...
On July 1, 2008, Moody’s publicly announced the results of the Company’s investigation into the issues raised in a May 21, 2008 newspaper report concerning a coding error in a model used in the rating process for certain constant-proportion debt obligations. The Company’s investigation determined that, in April 2007, members of a European rating surveillance committee engaged in conduct contrary to Moody’s Code of Professional Conduct.
On March 18, 2010, MIS received a "Wells Notice" from the Staff of the SEC stating that the Staff is considering recommending that the Commission institute administrative and cease-and-desist proceedings against MIS in connection with MIS’s initial June 2007 application on SEC Form NRSRO to register as a nationally recognized statistical rating organization under the Credit Rating Agency Reform Act of 2006. That application, which is publicly available on the Regulatory Affairs page of http://www.moodys.com, included a description of MIS’s procedures and principles for determining credit ratings.
The Staff has informed Moody’s that the recommendation it is considering is based on the theory that MIS’s description of its procedures and principles were rendered false and misleading as of the time the application was filed with the SEC in light of the Company’s finding that a rating committee policy had been violated. MIS disagrees with the Staff that the violation of a company policy by a company employee renders the policy itself false and misleading and has submitted a response to the Wells Notice explaining why its initial application was accurate and why it believes an enforcement action is unwarranted.
Popcorns ready!
Moody's is going down like Arthur Andersen! A Wells Notice is never good for business. The sounds you hear is Warren Buffet dumping Moody's out of his portfolio in after-hours trading.
And trust me, I will take much glee in watching Moody's get shorted by the very wolves they created.
Poetic Justice in a way.
So why did they get this Wells Notice?
Let's let the Federal Reserve explain it to us!
http://www.federalreserve.gov/...
The Constant Proportion Debt Obligation (CPDO) appeared at the peak of the market for structured credit products. The first CPDO issue, ABN Amro’s Surf, was arranged in the summer of 2006 and closed in November of the same year. The Surf notes were rated AAA by Standard & Poor’s, yet offered a coupon 200 basis points over LIBOR. As the AAA corporate spread in this period hovered close to LIBOR, the Surf deal earned considerable attention (not all sanguine) in the financial press and industry awards such as Risk Magazine’s "Deal of the Year" in February 2007. When credit markets came under stress in 2007, CPDOs were among the first to unravel. The first CPDO default, on a financial-only CPDO issued by UBS, arrived in late November 2007. The defaulted notes had been rated Aaa by Moody’s at issuance in March 2007. To have met this rating standard, the modeled likelihood of default within a year must have been less than 1 in 250,000. Since 1920, no Aaa rated corporate bond has ever defaulted within a two year horizon. Subsequently, it appears that most CPDOs were unwound voluntarily by investors, at significant loss, or forcibly unwound. Our calculations suggest that most or all of any remaining CPDO notes would likely have defaulted by late November 2008.
Page 19
In a series of articles beginning on May 21, 2008, the Financial Times blog "FT Alphaville" (hereafter simply "FT") reports that internal documents leaked from Moody’s show senior staff at the rating agency learned in early 2007 of a coding error in the implementation of the model used to rated CPDOs. FT reports that had the error been corrected, the Aaa rated notes would have been rated up to four notches lower. Even so, FT reports that CPDOs rated after the discovery of the bug still achieved the Aaa rating because Moody’s, while correcting the error, made two offsetting modifications to the rating methodology.25 Of the two, the most"notable" (in the phrase of the FT article) was the imposition of volatility caps in the spread processes.
25
As reported by FT, the leaked documents say of the methodology changes that "the impact of our code issue after these improvements is then reduced." According to the FT, a third methodological change was proposed but not implemented as, according to leaked documents, it "did not help the rating." On September 4, 2008, Moody’s reported the discovery of one more (unspecified) error in the implementation of their CPDO rating model. The correction of the error, according to Bloomberg News, would likely result in a downgrade of the affected CPDOs by one or two notches.
Page 24
Finally, from the perspective of Moody’s model, another anomaly of 2007 is the sectoral variation in ratings-based spreads. Sectoral concentration in the Moody’s model is addressed via the ratings migration correlation structure of the CDOROM/LSS module. That is, there may be sectoral risk in ratings migration but, conditional on the realized ratings of the obligors, there is no sectoral or idiosyncratic risk in spread movements. For financial obligors in 2007, this stylized characterization of risk proved inadequate. Of the four identifiable obligors included in the failed UBS financial-only CPDO, none suffered any downgrade up to the unwind date, and all remained A-rated or better. However, as demonstrated in Figure 3, the market assessment of these obligors differed sharply from that of the rating agencies.
Well okay, shit happens, right?
It's not like they intentionally over-rated countless exotic instruments on purpose, such a thing would be criminal.
[CPDO rating error] Moody’s ousts structured finance head, admits breaches to code of conduct
Posted by Sam Jones, FT Alphaville, Jul 01, 2008
http://ftalphaville.ft.com/...
NEW YORK, Jul 01, 2008 (BUSINESS WIRE) — Moody’s Investors Service, the credit rating agency unit of Moody’s Corporation (NYSE: MCO), today announced that, following a comprehensive review of its ratings process for European constant-proportion debt obligations (CPDO), it has initiated employee disciplinary proceedings and accelerated measures to strengthen its rating and monitoring processes.
Moody’s found, based on an investigation conducted by the law firm Sullivan & Cromwell, that its personnel did not make changes to the methodology for rating European CPDOs to mask any model error. Moody’s, however, has concluded that members of a European CPDO monitoring committee engaged in conduct contrary to Moody’s Code of Professional Conduct. Specifically, some committee members considered factors inappropriate to the rating process when reviewing CPDO ratings following the discovery of the model error. According to Moody’s Code of Professional Conduct, a committee may consider only credit factors relevant to the credit assessment and may not consider the potential impact on Moody’s, or on an issuer, an investor or other market participant.
"I am deeply disappointed by the conduct that occurred in this incident," said Moody’s Chairman and CEO, Raymond McDaniel. "The integrity of our rating process is core to Moody’s values and is essential to the market. If an error occurs, it is crucial that rating committees consider possible rating changes and disclosures in an appropriate manner. In this instance, monitoring committee members considered issues not relevant to the rating process in reaching their conclusions. In response, we are taking immediate and appropriate action to address the lapse in our rating process and to ensure that a similar event does not occur again."
Well son of a gun.
Now imagine a world, where people knew the models were wrong, and did not fix them.
Imagine a world where certain financial houses knew this, and bet against them.
And imagine all the poor institutional investors who thought they had bought bonds that had never failed but were actually rated wrong, and in some cases, never rated correctly.
Imagine no more, because the gun is smoking.