Wednesday, October 15, 2008

Picking Up Markers: Reform and Re-regulation Watch

Some bloggers have been peeked by this article from the WSJ, The 1% Panic. Without 100 words, that write-up goes in the wrong direction, I think.

I'm more interested in something I heard to day, about how people learned to game models, namely the models Moody's uses. (Apologies to readers, if I'm the last one in the room to get this "news").


Here's how it goes.

A long while back (up to ten years ago?), Moody's started to use market-based metrics, as inputs to their decisions about upgrading and downgrading, because their studies showed that their ratings changes were anticipated by the markets, that they were consistently "late", and that the market, frankly, was pretty good at judging changes in the financial condition of companies, even without non-public information.

Apart from the name of the firm that pioneered that effort, I have no inside info on their process - just to be clear.

What appears may have happened is that speculators in the credit markets pushed vulnerable credits to the brink, nudged the ratings agencies to "confirm", and then pocketed the results of their "push" on the far-side. Translate "speculators" to fast-money hedge-funds.

In other words, it *may* have become possible, for a time, to manipulate the "new" credit markets.

This is quite different than the kind of 'model risk' that everyone knows exists on Wall Street. It's very different than having guessed wrong about the default rates on sub-prime mortgages. This is (old fahsioned) market manipulation - you know, the jailing kind of abuse.

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