CDS

SEC Bombs and Moody's Blasts

spy vs spyKing of the Click Business Insider has alerted us all to an obscure comment on a proposed SEC rule for Nationally Recognized Statistical Rating Organizations. William J. Harrington, is a former Moody's Senior Vice President in the derivatives analyst group from 1999-2010. In Harrington's 80 page comment, he starts with this opening salvo:

Moody’s argues that RMBS committees could not have factored the collapse of real estate prices into their opinions, given that the scale of the collapse was both unprecedented and unforeseeable. This rationale is as unconvincing as it is disingenuous, for it pretends that Moody’s and other financial players were not designing and operating the conveyances that carried real estate prices to unsustainable levels in the first place. A roller coaster inexorably chugs up to stomach-turning heights before it hurtles downward, and both a carnival operator
and a thrill seeker understand the nature of the ride’s operations.

The rationale of “who could know?” is wholly undone through even a cursory examination of the actions of Moody’s and other financial players in the structured finance sector. Moody’s and other financial players took care to protect their earning should the real estate bubble that they were ushering into the world subsequently collapse.

Government in the Securitization Business

Thought bail outs were over?   Think again.    Last Friday the government bought $50 billion in toxic assets from three corporate credit unions.

The government’s National Credit Union Administration seized three corporate credit unions on Friday and announced a plan to separate the $50 billion of troubled assets from the industry.

What is a corporate credit union you ask? A corporate credit union is kind of a wholesale or bank to the regular credit unions which consumers use.

The NCUA press release overviews their Corporate System Resolution to deal with buying billions of worthless crap derivatives. What are they doing? Repackaging $50 billion in worthless derivatives as $35 billion in government backed derivatives. I kid you not. The government is in the securitization business.

La de da, look at the NCUA's statement on how the corporate credit unions got into trouble:

Several large corporate credit unions made large investments in private label mortgage-backed securities that are now worth much less than the amount the corporates originally paid for them. This affected corporate credit unions in two significant ways.

Derivatives, derivatives, derivatives!

Over and over again, we discover, upon some obscure audit or forensic accounting report being published, derivatives were the real culprit behind some bank/credit union/country failing.

Now we have Greece considering suing U.S. banks over credit default swaps on their sovereign debt and other derivatives.

Greece is considering taking legal action against U.S. investment banks that might have contributed to the country’s debt crisis, Prime Minister George Papandreou said.

“I wouldn’t rule out that this may be a recourse,” Papandreou said.

While this interview is making headlines buzz, to read the details of why Greece would consider suing U.S. banks click here and here

What a surprise, having a vehicle that pays out hansomely if a nation defaults on their debt might create some shady dealings. Bloomberg:

European Central Bank President Jean-Claude Trichet said May 6 that he was concerned about speculation in bond markets using credit default swaps. “By first buying the CDS and then trying to affect market sentiment by going short on the underlying bond, investors can make large profits,” he said.

Economic Warfare? Europe versus Wall Street


Michael Collins

(March 10) Wall Streets is headed toward international pariah status thanks to two recent actions by the European Union (EU).

On Tuesday, the EU announced that it was banning Wall Street banks from the lucrative government bond business in Europe. They didn't express official concern or fire off a warning shot. They simply banned Wall Street from financing government bond deals like the one Goldman Sachs sold to Greece. The Guardian pointed out that Wall Street bond business from European governments has gone down over the last two years. Now the business is gone period. In effect, the EU has labeled Wall Streets business tactics as too dangerous for their governments to handle.

Pricing a CDO - Not only Bad Math, Bad Computation too

A working paper, Computational complexity and informational asymmetry in financial products, Sanjeev Arora, Boaz Barak, Markus Brunnermeier, Rong Ge. sheds some light on the complex mathematical models upon which credit default obligations and other derivatives are based.

What Arora et al. prove is not only are many derivative mathematical models impossible to compute, never mind in real time, because they require more computing power than the world possesses, the missing information to run a mathematical model is a very good place to cheat with.

To understand what CDOs, derivatives are, see this post, complete with video tutorials. For some background on the mathematics behind derivatives, read We Want the Formula and this one on some of the probability functions.

Onto the paper. Firstly this quote:

One of our main results suggests that it may be computationally intractable to price derivatives even when buyers know almost all of the relevant information, and furthermore this is true even in very simple models of asset yields.

What is Behind the Curtain - Lehman CDS Auction Gives a Hint

Wizard of Oz Behind the Curtain

 

The Final Price for Lehman Brothers CDS auction is 8.625. That's 8.625% on the dollar and is much less than what was expected, 9.75.

 

That means CDS Lehman sellers have to pony up 91.375 cents on the dollar. That's the Biggest Payout Ever and will assuredly result in further write downs and losses for these sellers.

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