Moody's software bug screws investors

Moody's, a major credit rating agency, incorrectly awarded its top rating to $4 billion of risky debt due to a software bug in the company's mathematical models. The incorrect ratings misled investors into believing they could earn "very high returns with little risk," according to the Financial Times. Some investors lost 60% of their investment as a result.

MoodyÂ’s software bug screws investors

Moody's, a major credit rating agency, incorrectly awarded its top rating to $4 billion of risky debt due to a software bug in the company's mathematical models. The incorrect ratings misled investors into believing they could earn "very high returns with little risk," according to the Financial Times. Some investors lost 60% of their investment as a result.

The Financial Times elaborated:

In a time of ever shrinking returns from investments in credit at the height of a raging bull market, early versions of these highly structured and complex deals promised to pay 200 basis points – that is 2 percentage points – over Libor, or the “risk-free” rate at which banks lend to each other. And that spread came with the top-notch triple A ratings that indicate an incredibly low probability that investors could lose their money.

Charles Shumer, Senator from New York, has called for an SEC investigation into Moody's handling of the situation:

“The ratings inaccuracies that were disclosed are deeply troubling,” Mr Schumer wrote in a letter sent Wednesday. “However, the fact that Moody’s only downgraded these incorrectly rated products in January of 2008, nearly a full year after they became aware of the problem, is much worse, and is indicative of a culture of shirking responsibility that must end.”

Computerworld UK quotes Ralph Silva, senior analyst at financial services advisory firm Tower Group, regarding rating agencies' lackadaisical attitude toward technology management:

Ratings agencies never put sufficient emphasis on their technology resources,” he said. In spite of technology playing a key part in ratings decisions, “they simply haven’t felt getting technology right was important enough to business processes, unlike banks”.

The end-user impact of computer failures in cases such as this cannot be overstated. Anyone who thinks otherwise should ask the affected investors. Computerworld UK blogger, Mike Simons, summarized the situation well:

It shows both the power of the systems IT professionals build and manage and the stupidity of anyone in suspending disbelief because a computer system tells them black is white. It also highlights the governance issues involved in rectifying mistakes.

Technology problems, whether in the form of unanticipated hardware failures or software bugs, can be notoriously hard to predict and prevent. Since preventing technology failure isn't always achievable, responsible management policies and governance are critical tools to minimize failure's impact on users.

Moody's mathematical bug, exacerbated by management's delay acknowledging the problem, caused the company's stock price to drop substantially, may spark a federal investigation, and hurt innocent investors. This situation reminds us that even obscure software bugs can have enormous impact in the real world.

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