Thursday, May 13, 2010

The CDO-prosecution bandwagon gathers more steam

FT Alphaville's Gwen Robinson reports that:
New York’s ever-vigilant attorney general Andrew Cuomo is at it again, this time with an investigation into whether eight banks gave misleading information to rating agencies in order to boost the ratings on particular mortgage securities.

As the New York Times reports:

The agencies themselves have been widely criticized for overstating the quality of many mortgage securities that ended up losing money once the housing market collapsed. The inquiry by the attorney general of New York, Andrew M. Cuomo, suggests that he thinks the agencies may have been duped by one or more of the targets of his investigation.

Those targets are Goldman Sachs, Morgan Stanley, UBS, Citigroup, Credit Suisse, Deutsche Bank, Crédit Agricole and Merrill Lynch, which is now owned by Bank of America.

The companies that rated the mortgage deals are Standard & Poor’s, Fitch Ratings and Moody’s Investors Service. Investors used their ratings to decide whether to buy mortgage securities.

The probe parallels federal inquiries into a wide range of financial companies in the years leading up to the collapse of the housing market. But, as the Times notes, whereas the federal probes have focused on interactions between the banks and their clients who bought mortgage securities, “this one expands the scope of scrutiny to the interplay between banks and the agencies that rate their securities”.

For the rest of the article go to: ftalphaville.ft.com/blog/2010/05/13/230081/cuomo-targets-beyond-the-ratings-agencies/ See also Yves Smith's post at Naked Capitalism: www.nakedcapitalism.com/2010/05/were-the-ratings-agencies-duped-rather-than-dumb.html

The interesting bit is from a legal standpoint, the logical response for the investment banks would be to say the credit agency models were bunk, the way that correlation models that were developed in the corporate loan market were repurposed to the asset backed securities market was problematic. But the difficulty here is the banks were hawking correlation products and correlation trading strategies; they were even deeper into these approaches than the rating agencies. So Cuomo may indeed be able to land a very solid blow if his inquiry does establish that the investment banks misrepresented

And at Reuters Felix Salmon updates us on the Abacus situation:

Meanwhile, the WSJ has a bit more information on the case against Morgan Stanley, adding that it’s not only Dead Presidents but also deals named ABSpoke and Baldwin being looked at:

Some CDO offering documents indicated that mortgage assets selected for the deals may have factored in the interests of market players whose interests were “adverse” to other investors. But none went as far as to state that hedge funds or banks’ trading desks were making bets against the deals for their own accounts, according to documents reviewed by the Journal.

This is essentially a slightly weaker version of the case against Goldman in the Abacus deal. In that case, the SEC is saying that Goldman implied to investors that the person structuring the deal was long when in fact he was massively short. In these cases, the banks did make a disclosure about adverse interests, but didn’t go as far as they should have done in terms of revealing that they themselves intended to hold on to the short position.

Again, the same political calculus applies: it’s incredibly dangerous to take the Goldman route of fighting the accusations aggressively. Better, I think, to just cooperate fully with the SEC and see what happens. And, of course, if and when the relevant Wells notice arrives, to disclose that fact to investors immediately.

For the rest of the article go to: blogs.reuters.com/felix-salmon/2010/05/13/the-cdo-prosecution-bandwagon-gathers-more-steam/. Also Tracy Alloway at FT Alphaville is providing more detail on the Morgan Stanley "Dead Presidents" deals here: ftalphaville.ft.com/blog/2010/05/13/229771/dead-presidents-in-detail/

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