I have long said that I am not impressed with efficient market theories about the genius and rationality of capital markets in asset pricing. Markets can often be just plain dumb, driven by irrational and erroneous assumptions of emotional participants.
Here is the latest example. Today the Financial Times reports Moody’s awarded incorrect triple-A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models!! See Moody’s error gave top ratings to debt products and watch this short news clip for Monty-Python-esque impact.
Although the error was apparently discovered by some Moody's insiders in 2007, the products in question remained triple A until January this year when, amid general market declines, they were downgraded several notches. The products were designed for institutional investors. In the recent credit market turmoil, those who still hold the products will have suffered some paper losses while others who have bailed out have lost up to 60 per cent of their investment.
This is a common skit that we have seen many times in the financial world. The asset holders lose big chunks of their capital. They turn to the asset advisors and say you gave us bad advice. The asset advisors turn to the product creators and raters and say you designed bad products. The product creators and rating agencies say it’s not our fault the computer screwed up. Conveniently, no one is there to accept the blame when the music stops, though many made enormous fees passing the potato ‘round and ‘round while the music played.
Oh yes, and there is nothing risky about the current price of oil either…the computer models all agree that demand is accurately setting the price.
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