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Moody's Blew It

It looks like there is yet another link in the chain of corruption and/or incompetence that led to the subprime crisis. As time goes on and information about the crisis reveals itself, it seems that every link in the financial chain featured people afflicted with an adversity toward doing the right thing.

Who is it this time?
On Wednesday, the Financial Times reported that a coding error at Moody's (NYSE: MCO  ) resulted in improper ratings for about $4 billion of complex European debt products called Constant Proportion Debt Obligations (CPDOs). After the news report, Moody's said that a computer problem resulted in incorrect AAA ratings for the debt, and the debt actually deserved a rating four notches lower. The news sent the stock reeling more than 13% on Wednesday, the single worst day in the stock's history.

The FT also reported that it possessed internal documents that showed the rating agency was aware of the glitch in early 2007, yet still maintained the AAA rating until early 2008, when market turmoil in the debt markets led to downgrades. This suggests that there could have been an attempt at a cover-up.

The besieged debt rating agency announced Wednesday that it has hired the law firm of Sullivan and Cromwell to conduct a "thorough external review" of the ratings process it used. I'm sure Moody's is anxious to get to the bottom of it.

What's the damage?
Damage from the subprime crisis has been catastrophic. According to Fitch, losses from subprime mortgages and prepackaged loans, such as those offered by Citigroup (NYSE: C  ) , UBS, Wachovia, Merrill Lynch (NYSE: MER  ) , and Bank of America (NYSE: BAC  ) , have already totaled more than $400 billion.

The major rating agencies -- Moody's, McGraw-Hill's (NYSE: MHP  ) Standard & Poor's, and Fitch -- have already been sharply criticized for incorrectly rating subprime mortgage debt. This latest fiasco just confirms the most cynical suspicions. Moody's looks either corrupt or incompetent.

The fallout from this for Moody's shareholders has not been pretty. The stock has already plummeted more than 50% from its 52-week high and some 20% since this story broke.

The issue with a computer glitch and, worse, possible confirmation of many people's suspicions, can only harm investor's confidence in the company's integrity. That integrity is the company's sole stock in trade. Without it, the firm could find it difficult to even survive.

Related Foolishness:

Bank of America is a Motley Fool Income Investor recommendation. Moody's is both a Stock Advisor and Inside Value recommendation, and McGraw-Hill is an Inside Value choice. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Tom Hutchinson holds no financial position in any companies mentioned. The Motley Fool has a disclosure policy.

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