Posted on FT's Alphaville by Tracy Alloway:
Expensive wines and toxic assets are rarely mentioned in the same breath.
But that was the talk at UBS during the summer of 2007, when the Swiss banking giant sold some $35 million in soon-to-be rotten collateralized debt obligations to Pursuit Partners, a Connecticut hedge fund, which is now suing the bank.
Last week, a Connecticut judge ruled that Pursuit had presented sufficient evidence that UBS sold the CDOs even though the bank had confidential information that Moody’s Investors Service was planning to slash its credit ratings on those subprime-backed securities.
The judge, in issuing a preliminary ruling against UBS, cited an internal UBS email that has received a fair amount of attention because a trader boasted: “Sold some more crap to Pursuit.”
But it’s the email exchange leading up to that trader’s comment, which wasn’t included in the judge’s decision but was obtained by Reuters, that may be just as revealing.
Much of the discussion between trader Evan Malik and a colleague concerns the amount of money they’d each spent on a 2000 vintage bottle of wine. The sale of the “crap” CDOs almost seems an afterthought in the email thread titled: “95pts Wine Spec. Best Tignanello since 1997.”
On the anniversary of the implosion of Lehman Brothers, it’s important to remember that the financial crisis really began a full year earlier — in July 2007 — with the collapse of two Bear Stearns hedge funds that had loaded up on CDOs.
Back then, few on Wall Street, let alone at the Federal Reserve or the White House, foresaw the carnage and bailouts to come.
In summer 2007, most thought the credit crunch — as it was called back then — would be a manageable episode that might cause pain for a few hedge funds and banks that made lots of mortgages to subprime borrowers. Most laughed at the prospect of Bear Stearns suffering lasting damage from the meltdown of its once giant hedge funds.
Stocks continued to rally higher and higher, with the Dow Jones Industrial Average eventually peaking at 14,164 on October 9, 2007. That “what, me worry?” mindset may explain why a supposedly savvy investor like Pursuit would purchase CDOs from UBS, even after the Bear funds had melted down.
That’s why the most interesting thing to come out of the emails turned over by UBS are the exchanges that show the firm’s mortgage trading desk was being kept “in the loop” about the firm’s conversations with Moody’s on the eventual CDO downgrades in October 2007.
As I pointed out in a column, the real issue in this lawsuit is one of insider trading — whether UBS, which says it expects to prevail in this case, was taking advantage of Pursuit with information it had gotten from those private conversations with Moody’s.
On that score, the most damaging email may be one from July 2007 that alerts UBS’ trading desk to an upcoming meeting between Moody’s and the investment bank’s chief risk officer. Moody’s was arranging the meeting with UBS and other investment banks “to discuss impacts” of potential downgrades to subprime-mortgage backed securities.
The email indicates that higher-ups on the UBS trading desk were alerted to these potential rating changes.
It also raises the question of whether the expectation was that the desk would trade on that information — although nothing that explicit ever appears in the email thread.
The email offers a window into how confidential information can get passed along within a Wall Street firm and sometimes be
traded on. (Here’s a link to some of the UBS emails obtained by Reuters).
To be fair, there’s nothing in the emails turned over by UBS that indicates how detailed Moody’s was about the timing of the CDO downgrades. (Moody’s has called the accusations in the lawsuit baseless.)
But now that the judge has issued a preliminary finding in Pursuit’s favor, it is likely that UBS will be required to turn over any additional emails or documents that may shed further light on the discussions its credit risk team had with Moody’s.
And it’s fair to assume that Pursuit wasn’t the only hedge fund or institutional investor buying “crap” from UBS in the summer of 2007. The Pursuit case looks like it could become a much bigger headache for UBS than anyone imagined.