A report by the US Securities and Exchange Commission has claimed that credit ratings agency Moody’s decided not to take action after discovering a computer glitch had caused it to give controversial investment products a high rating.
However, the SEC will not investigate whether this decision was fraudulent because it took place outside the US.
In May 2008, it was revealed that Moody’s had given AAA ratings to investment products called ‘constant proportion debt obligations’ – thereby implying they were a good investment – as a result of a bug in its financial modeling systems.
CPDOs are a way of packaging corporate debt into a long-term investment. When businesses began to default on their credit payments, many CPDOs plummeted in value. The Financial Times’ Alphaville column recently described CPDOs as “basically the poster children for what was wrong with the structured finance market in the years before the financial crisis”.
According to a report issued by the SEC yesterday, a Moody’s analyst discovered the glitch in early 2007 but “shortly thereafter during a meeting in Europe, a … rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact [Moody’s] business reputation.”
The SEC said that it would not investigate the legality of this decision because it had taken place in Europe and therefore may not fall under its jurisdiction. “Because of uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct,” it said, “the Commission declined to pursue a fraud enforcement action in this matter.”
A recent working paper by the US Federal Reserve said the Moody’s computer glitch was not the principal cause for CPDOs being overvalued by investors, pointing out that Standard and Poor’s also gave the products an AAA rating. But it did say that the models used by such agencies to assess the products had drastically underestimated the likelihood of widespread credit defaults.