Internal Moody's documents reviewed by reporters from the Financial Times, however, indicated that senior staff at Moody's were aware in February 2007 that a glitch in some computer models rated CPDOs as much as 3.5 levels higher in the Moody's metric than they should have been. As a result, Moody's advertised CPDOs as significantly less risky than they actually were until the ratings were corrected in early 2008.
Institutional investors typically rely on ratings from at least two companies before they put significant money into a new financial product. Standard & Poor's had previously rated CPDOs with its highest AAA rating, and stood by its evaluation.
Moody's AAA rating provided the critical second rating that spurred investors to begin purchasing CPDOs. But other bond-ratings firms didn't rate CPDO transactions as highly; John Schiavetta, head of global structured credit at Derivative Fitch in New York, was quoted in the Financial Times in April 2007, saying, "We think the first generation of CPDO transactions are overrated."
Among the US-based financial institutions that put together CPDO portfolios, trying to cash in on what, in late 2006, seemed to be a gold rush in investments, were Lehman Brothers, Merrill Lynch, and JP Morgan.
When first reported this past May, the Financial Times story described the bug in Moody's rating system as "nothing more than a mathematical typo -- a small glitch in a line of computer code." But this glitch may have contributed in some measure to the disastrous financial situation all around us.
It's kind of hard to come up with a snarky one-liner for a foul-up like that.
Testing tip: When testing something as critical as this, run commonsense trials: Throw variations of data at the formula, and make sure you get the expected result each time. You also have to audit your code periodically with an outside firm, to ensure that a vested insider hasn't "accidentally" inserted a mathematical error that nets the insider millions. There's no indication that such an inside job happened in this case, but such a scenario isn't so far-fetched that it's beyond the realm of possibility.