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Morgan Stanley Is Next Target Of CDO Fraud Probe
The WSJ reports that "Federal prosecutors are investigating whether Morgan Stanley misled investors about mortgage-derivatives deals it helped design and sometimes bet against, people familiar with the matter say, in a step that intensifies Washington's scrutiny of Wall Street in the wake of the financial crisis." In essence, Abacus comes to Times Square. And the latest soundbite for today's media feeding frenzy: the "Dead Presidents." So going down the list: Goldman - check, Morgan Stanley -check, Merrill,
Deutsche and UBS - to come, especially once Khuzami finds a replacement
to fill his recused status when investigating the German bank.
Among the deals that have been scrutinized are two named after U.S. Presidents James Buchanan and Andrew Jackson, a person familiar with the matter says. Morgan Stanley helped design the deals and bet against them, but didn't market them to clients. Traders called them the "Dead Presidents" deals.
However, even here, and not unlike Goldman which was flawless in trading last quarter, while MS lost money on a whopping 4 days, the impact to MS was much less from this "hedging" activity, after the firm ended up losing $9 billion in 2007 on mortgage related deals.
Morgan Stanley wasn't among the biggest players in the CDO market.
Although the firm made money on the Dead President deals, any profit
was far overshadowed by the $9 billion the firm lost on bullish
mortgage bets in 2007, a person familiar with the matter said.
As we discussed it previously, the Morgan Stanley CDO loss was among the biggest ever in prop trading history. But don't worry - banks now are prudent when using zero cost of capital discount window money direct from US taxpayers. After all what hedge fund has ever blown up when using free money. Which is why Chris Dodd had nothing to say about it - it must be under control.
We can't wait to see how far down the food chain the fraud investigation goes. Surely, with every firm in the US having done precisely what GS and MS are accused of doing, some heads will have to roll or else not only the SEC but all the various DA offices will look completely toothless when dealing with the Wall Street based masters of the universe.
One feature of the Morgan Stanley deals was a structure that could increase the magnitude of the bullish investors' exposures to the underlying mortgage bonds. This feature, which was disclosed in some offering documents, made it more likely that such investors could lose money if the underlying bonds performed poorly.
Morgan Stanley traders took the more profitable, bearish side of these transactions, according to traders. These positions weren't disclosed in some deals. It couldn't be determined how much money Morgan Stanley made with these wagers.
The SEC's industry-wide civil investigation into Wall Street activities in selling CDOs began in 2009. Beginning earlier this year, prosecutors from the Manhattan U.S. attorney's office began showing up to meetings arranged by SEC investigators who were questioning individuals about their firms' practices, people familiar with the matter say.
There have been several rounds of SEC subpoenas issued in the probe, a person familiar with the matter says. Last summer, the SEC asked Wall Street firms about any of their clients that were betting against CDOs, the person says. In the fall, Morgan Stanley provided offering documents to the SEC about CDOs, including its Dead Presidents deals. Morgan Stanley, among other firms, received a subpoena in December 2009 asking about its sale and marketing of CDOs, people familiar with the matter say.
In the past six weeks, a fresh round of SEC subpoenas have asked a smaller number of Wall Street firms for a broad range of information on CDO deals, including prospectuses, offering documents and other data that would include disclosure statements.
On an April 21, 2010, conference call with investors and analysts, Morgan Stanley Chief Financial Officer Ruth Porat responded to an analyst question, saying "we have not received a Wells notice in connection with our CDO business." Wells notices inform firms or individuals that the SEC's enforcement staff plans to recommend that the agency bring charges.
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Yeah I saw that on Bloomberg but MS denies any probe from the SEC and DOJ at this point so this begs me to question who leaked this story? Rumors on other financial companies were all the rage in 2008 before the chaos came. Now who do we know that leaks negative info against competitors?
Good point, some business flowing out of the Squid's tentacles towards the closest competitor much?
Wake me up when the headlines change from "probing" to "proved without a doubt and fined" WSJ's credibility is plunging by the day after Murdock took over and painted it yellow anyway. There must be hundreds of such deals being on the desks of the SEC pornsurfers at any given time, that doesn't mean it will be easy to prove they created, marketed, sold and bet against the CDOs considering they almost went under considering they lost 9 bln in 2007 on these.
SEC schmuks better lobby to return Glass-Steagal, it was Washington that created the mess in the first place, IBs only got what was handed to them and everybody'd hands got greased in the meantime...
I am truly shocked by these surprising developments.
There is nothing to investigate - the whole system is corrupt beyond repair. Who is going to investigate the investigators? eh? We already have the largest population of jailbirds in the world. jails may actually be a pretty good deal - 3 meals a day , time to exercise in the yard, no responsibilities and plenty of time to read. So what are they going to do when a line forms to get into jail? I have an idea - run a lottery!
Yawwwwwwnnnnnnn.
Hoooooooohummmmmmmmmm.
End up, all of em with a fine .0025% of last 5 years bonuses.
"Admission of no wrongdoing."
Nothing to see here, Oh that? Ignore that little ol blackhole......Move along, move along.
Yawn.
So, did MS not lose enough money messing around with CDOs or what's the big deal here exactly?
If some of the deals that MS lost $9bil on were synthetic CDOs doesn't that mean that whoever they sold the other side to won?
No more violins for dumb money please. At least they could have refused those deals.
Let's concentrate on the far more important Live President Debt Obligations being cooked up in Washington right now - the one's we can't refuse to participate in.
I wonder if the SEC will look into the prop bet market next, going after someone who bet on Obama winning the presidency by selling President.2008.McCain contracts.
"You sold those contracts knowing full well that McCain didn't have hope or change!"
The surprise to me is not hearing anything mentioned about JPM.
Sources inside the SEC tell me that the reason Morgan Stanley is being investigated is because, unlike rivals Goldman and JPM, Morgan had three losing prop trading days last quarter. This is considered unacceptable, because it implies Morgan was actually not net long on at least three days.
Expect harsh sentences and perhaps a token execution or two. There are rules, after all.
Do we really believe the DOJ is going to do something here????
A good overview of the deals MS is being probed for (thanks, JaketheSnake on Reuters!) - anyone still thinks they'll get more than a fine on technicalities? :
"The deal feature that they are alluding to is probably Auto Reinvest. Auto Reinvest was a feature of synthetic ABS deals that worked to keep ABS CDOs outstanding as long as possible because clients didn’t want to have to continually buy more ABS CDOs as the deals amortized (and risk losing there already amazing 20-50bps of coupon). In fact, to my knowledge, a client came up with the structure in the first place!
The short explanation of how it works is as follows: Subprime mortgage bonds amortize so ABS CDOs amortize (or were supposed to). On a synthetic deal, you could structure the CDS contracts underlying the CDOs to reference a specific subprime mortgage bond but allow the notional that was referenced on the underlying bond to change over time. As the underlying bond amortizes, you simply have the amount of notional increase by the same amount. In this way, there is no amortization on the top level CDO tranches. At a certain point (usually 10-20% of original face), the notional is amortized down at 5-10 times the rate of the underlying mortgage security, thus paying off the tranche.
The rub here is that, because the underlying mezzanine subprime mortgage bonds would, in the best case, likely pay down pro rata with the rest of the structure, you are increasingly becoming exposed to the bottom 20% of the collateral pool underlying the deal. This is problematic even in a non subprime meltdown scenario because the tails of these pools, even to casual observers, were cuspy at best.
Now, one thing that I find bizarre about this whole investigation is that Morgan Stanley had no involvement in the marketing of this deal. They played a similar role to Paulson, who wasn’t investigated.
And for the record, no CPDO on ABS ever got done."