Presenting The Latest Eurodebt Exposure Masking Scam Courtesy Of Morgan Stanley: Level 1 To Level 2 Transfers

Tyler Durden's picture

For the latest gimmick to mask PIIGS sovereign debt exposure (where we already know that the traditional fallback of "gross being irrelevant and only net being important" crashed and burned today after Jefferies offloaded precisely half of its gross exposure, while raising net, thereby confirming that gross exposure is indeed a risk), we turn yet again to Morgan Stanley. As a reminder, despite our note that the company's gross exposure (which is now a major risk factor, thank you Rich Handler for proving our "bilateral netting is flawed" thesis) to French banks alone is $39 billion, Morgan Stanley downplayed this by saying that only $2.1 billion is the actual net funded exposure to Peripherals Eurozone countries. We'll see if Jack Gorman will have to revisit his defense after today's Jefferies action. Well as it turns out, we now have gimmick number two, one which will surely delight the bearish investors out there looking to find a bank doing all it can to mask not only its gross but net exposure (and wondering why it has to resort to such shenanigans). Presenting the Level 1 to Level 2 switcheroo, courtesy of, who else, Morgan Stanley.

From the just released 10-Q:

"Financial instruments owned—Other sovereign government obligations.    During the quarter ended September 30, 2011, the Company reclassified approximately $1.8 billion of other sovereign government obligations assets and approximately $2.1 billion of other sovereign government obligations liabilities from Level 1 to Level 2. These reclassifications primarily related to European peripheral government bonds as transactions in these securities did not occur with sufficient frequency and volume to constitute an active."

Uhm, are you serious? Transactions in all PIIGS securities were sufficiently active in both frequency and volume. We are delighted to present Morgan Stanley with a CUSIP list of all PIIGS bonds together with price and volume data if they so desire to confirm to them that their excuse is about to get tested substantially by the market as one not of prudent accounting (we jest: Level 2 assets are merely a legal way to get par marks for a security that is realistically trading at 35 cents on the dollar in the case of Greece and 87 in the case of Italy), but one of yet another attempt at blatant obfuscation.

And to confirm that this reasoning behind this reclassification in a quarter in which there was massive volatility in all PIIGS securities, is pure lunacy, we ask: did Morgan Stanley reclassify any PIIGS bonds from Level 1 to Level 2 in Q1 or Q2, when vol was indeed less and when one could make the argument that there is a basis for a Level 1 to Level 2 transition?

Here is the language for the 9 months ended, not just Q3:

Financial instruments owned—Other sovereign government obligations.    During the nine months ended September 30, 2011, the Company reclassified approximately $1.8 billion of other sovereign government obligations assets and approximately $2.1 billion of other sovereign government obligations liabilities from Level 1 to Level 2. These reclassifications primarily related to European peripheral government bonds as transactions in these securities did not occur with sufficient frequency and volume to constitute an active market.

So... the only time Morgan Stanley did the Level 1 to Level 2 shift was in Q3, when everything was trading, was volatile trades occurred in both "frequency" and "volume" yet when Morgan Stanley's back office couldn't find enough marks to justify keeping PIIGS bonds at Level 1? And let's not forget the fact that the Level 1 to Level 2 amount was $2.1 billion or... precisely the amount of the firm's self-professed net funded exposure!

SERIOUSLY, MORGAN STANLEY!?

Just like the DVA fudge, should we now expect every single bank to report a transfer in PIIGS exposure from Level 1 to Level 2 (only for Q3 mind you)? And if so, just how ugly is it about to get for US bank stocks with PIIGS exposure.

As for Morgan Stanley, please keep coming up with more and creative ways to mask the fact that your publicly disclosed net exposure to Europe is totally fabricated and meaningless. The market is just going to love picking off your Sovereign flow book at 1.5% gross losses (just like with Jefferies) as you scramble to offload your gross exposure next to prove, yet again, just how unexposed to Europe you "truly" are.

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Vlad Tepid's picture

But total fabricated bullshit is what makes Morgan Stanley Morgan Stanley!

BORT's picture

Early June, 2008

DoChenRollingBearing's picture

Are there any regulations in place that say that the banks have to show what bonds (etc.) they own?  If there is/were such transparency, than MS monkeying around Level 1 -> Level 2 would not matter if we could all see the toxic assets they might own...

NotApplicable's picture

So, rats fleeing a sinking ship is no longer considered "activity?"

These people are damn lucky that words have no meaning, otherwise, they'd be fucked.

Ned Zeppelin's picture

These are not the Level I assets you are looking for.

Mr Lennon Hendrix's picture

Comment of the day.

Ned wins a, "Timmah did my taxes, and all I got was this lousy t-shirt!"

Big Slick's picture

"These are not the Level I assets you are looking for."

Morgan Stanley can go about its business.

Lmo Mutton's picture

It's all fun and games till somebody needs a bailout.

jmcadg's picture

Like being caught at school with water bombs. It doesn't take much effort in hiding them in your pockets to make it look like you pissed yourself.

jcaz's picture

LOL- that's just classic......   Can't wait to see BAC come up with "Level 37".....

chump666's picture

Excellent post.

Hansel's picture

Yes.  Very well done Tyler.

kaiserhoff's picture

Fine post and series of posts on a complex subject.  A little light does make the cockroaches scurry.

Ponzi Unit's picture

3-card Monte played on polished mahogany instead of cardboard boxes.

adyaner's picture

Not panic at all, this is petty cash for uncle Ben who will purchase the exposure at 150% par value, to give some buffer to a friendly FED Shareholder...

Smartie37's picture

Looks like White Shoe stepped in Dog Dooooooooooo.......................    

ReallySparky's picture

Tyler, I sense some frustration in your prose.

apberusdisvet's picture

When you get to Level 5; does everything miraculously disappear?

Hey boss; we're on Level 4; only one more to go before your 9 zero bonus kicks in.

Unprepared's picture

"Hey! Show us your Level III exposure"

"There has never been a Level III in this firm."

"But where have you been hiding all that toxic stuff?"

"We recycle them"

"But how can you recycle toxic waste? You can only burry it."

"This firm never had a Level III"

"OK. What about Ground Zero then?"

knukles's picture

Same as: "Defcon Oh fuck me...."

Grinder74's picture

After level 5..."They just went plaid!"

mynhair's picture

Geez, it's only $39 billion.  My human burns that in a week.

Do wish he had hair....

kaiserhoff's picture

That muskrat toupee looks quite fetching on Donald Trump.

Better_late_than_never's picture

Did anyone see Cramer dodge the question about silver on Mad Money? Someone asked what would happen if the cftc "gets their act together" with the position limits. He called chicago the "wild west." ha ha

Grinder74's picture

Whorehouse on every corner? Check.

Community Bathhouse (Lake Michigan)? Check.

Rich guy from out East comes to rule the poor settlers? Check.

Every cowpoke has a gun? Oh, wait this is Chicago we're talking about.

Sequitur's picture

Level 2 and level 3 asset classifications: banker bullshit.

DollarDive's picture

Level 1, Level 2, Level 3 - Complete and utter bullshit fabrication.

Rules created to conceal.

Sunshine is the best disinfectant

Let the sunshine in.

 

topcallingtroll's picture

Looks like it.

Make sure u have a camera to photo all the skinnydippers.

chump666's picture

C'mon Berlusconi send a F*ck you to everything that is not Italian...you can do it.  

Europe is decending into chaos....

DollarDive's picture

Our bond markets have become a "SHAM". ;  

All the corporate bonds held in mutual funds and ETF's across America are completely overvalued.  Most bonds are priced off of a pricing grid.  The MF's pay 3rd party "price fixers" to tell them the price of their bonds.  Those prices have no bearing on reality.

Yet the funds use those prices from the "fixers" to determine the NAV of the MF's.

Wait until that market starts to cave.

It will implode on itself instantly when that selling starts to happen.

sgt_doom's picture

No offense intended, DollarDive, but it's been over 3 years since they discontinued mark-to-market.

Old news, guy......

topcallingtroll's picture

Thats not what he is talking about.

The appraisers have their "blue book" of bond values to rip off retail and help bond mutual funds look better.

Just like the real bluebook, the true value of some of these thinly traded bonds is a lot less than the published price.

DavidC's picture

Tyler,
Priceless! And brilliant.

Thank you.

DavidC

slewie the pi-rat's picture

can we get a DEFCON reading on this?

comfortablynumb's picture

To clarify....Level 2 gives them the ability not to use the last quoted price as you would with a Level 1.  They've basically had a (convenient) change in fair value accounting policy, I would love to see where they are marked at and what quotes/internal models they are using to value these bad boys.    

Iam_Silverman's picture

"They've basically had a (convenient) change in fair value accounting policy, I would love to see where they are marked at and what quotes/internal models they are using to value these bad boys.    "

This has to be the most concise and correct interpretation yet.

Thanks for clearing up the difference between Level I and Level II.  Although they are allowed to "Mark to Model", exactly how they model the predicted outcome is the most important theme here.  To model the end result, they need to be able to cherry pick the best return scenario based on a range in time, so changing the level makes sense.

CPL's picture

...riding on moonbeams while shitting skittles.

BetterOffDead's picture

The move to level 2 under FAS157 is inconsequential to the valuation, it is only a disclosure. If anything, it only invites more scrutiny as level one assets are generally reserved for exchange traded instruments with very active markets (the allocations between levels is somewhat subjective and differs from bank to bank). Assets in level three invite the most scrutiny as management judgement is almost exclusively relied on. I would be more worried if Euro sov debt was classified as level three when there have clearly been trades in the market place.

comfortablynumb's picture

You are right, I think Tyler's point was they changed policy for these and no longer use direct quotes from a valuation service (i.e. Bloomberg) leaving the ability to internally model or use some form of valuation other than a direct quote.  Theoretically should still be where market is quoting although who knows anymore. 

infinity8's picture

Ok, maybe a stupid question but, when they say "transactions in these securities did not occur with sufficient frequency and volume to constitute an active", are they talking about their transactions or transactions in general? Is there a rule for this type of reclassification?(not that it matters anymore)

infinity8's picture

whatev, comments just above me only serve to make me more confused. . . come on - I'm an honest poster here!

pain_and_soros's picture

the quote you bolded left out the word "market" at the end.

They are claiming that there were not enough transactions in the market (it was illiquid or not liquid enough) to be able to establish a reliable "mark" or price to value their bonds/investments...which Tyler showed was a pile of dung.

No hard & fast rule that I am aware of to apply in terms of necessary volume and frequency to be considered "active", but generally, if you could sell your holdings without influencing supply/moving price, then I would say you have an active market & price you can use to value your holdings...

 

 

infinity8's picture

Thank you! I was just wanting to make sure I understood what level of BS I'm dealing with in this instance.

infinity8's picture

so, fast and loose as usual, near as I can tell.