Did a coding error crash the economy?

May 22, 2008

Posted by: Mike Simons

A problem in the code used by financial ratings firm Moody’s may have contributed to the banking industry's headlong rush into “complex financial instruments” that ultimately led to the current global credit crunch.

That is the amazing tale broken yesterday by the Financial Times.

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.

The Financial Times tells how Moody’s gave its top rating, Triple A, to financial products that promised spectacular rates of return. Yet because of a coding error, the products should have had a significantly higher risk evaluation.

“It was nothing more than a mathematical typo – a small glitch in a line of computer code. The impact of the bug Moody’s analysts discovered was, nevertheless, significant,” said the FT.

As a result banks rushed to bring to market similar products, despite warnings from analysts and rival ratings agencies that “something was wrong” and the proposition was too good to be true.

So it proved. Moody’s spotted the flaw and set about correcting it –which has now led to a range of governance questions. The FT reported that senior managing directors at Moody’s discussed how to update the model and changes, “which had the effect of reducing the negative impact on the ratings of correcting the code error.”

Moody’s initial response was to say, “It would be inconsistent with Moody’s analytical standard and company policies to change methodologies in an effort to mask errors.”

This was followed up by a statement that, “The integrity of our ratings and rating methodologies is extremely important; as such … we retained the law firm of Sullivan & Cromwell and initiated a thorough external review of our … ratings process. Upon completion of the review, we will promptly take any appropriate actions.”

Quite right, but who wants to be in that position? Mistakes happen and the cost of putting them right in IT systems rises exponentially, the longer it is delayed.

So, a coding error probably didn’t bring the world economy to its knees, but it certainly contributed to the current problems. It could only do so because some in the financial services industry thought that IT systems were the tool of modern alchemists.

When something seems too good to be true, whether the message is delivered by a complex IT system or man selling Rolexes at your local street market, it is too good to be true.

Newsletters

Your daily injection of CW news and expert analysis: we’ll bring the news to you.