Friday, June 29, 2007

Conflict of Interest

The FT reports on the backfight behind the hedge fund troubles recently.
Dealers and investors who trade US subprime mortgage derivatives have rejected a proposed change to the terms of derivatives contracts from a hedge fund group concerned about possible manipulation of their value by investment banks.

More than 100 people descended on the New York offices of the International Swaps and Derivatives Association on Thursday to debate the proposal from Paulson & Co, the group’s leader.

Some banks are mortgage servicers as well as being lenders, underwriters for mortgage-backed securities and derivatives traders.

Looks like the bookies can still tweak the race results.

27 comments:

Orson Buggy said...

First Murst!

Anonymous said...

MURST!! MOIST!!!

Anonymous said...

How do you say third in Hater-speak?

Mird?

serinitis said...

I have seen this talked about a couple of times and I am totally confused by it. My understanding is the banks want to pull mortgages that they know are going bad out of pools that they are selling and the purchasers are objecting to this?

Could someone explain this for us simpletons a little better

Thank you

someotherpersonaltogether said...

“U.S. banking regulators told mortgage lenders to tighten standards for subprime home loans in a belated effort to end abuses that led to a surge in defaults and the highest foreclosure rate in five years. Lenders, in most cases, should verify income levels instead of relying on borrowers’ statements, the Federal Reserve and other banking regulators said in guidelines issued today.”

“They also said banks should account for potential interest-rate increases in scrutinizing whether homebuyers can pay off loans.”


El. Oh. El. Ya think?

Rob Dawg said...

Serinitis,
You and me both. Calculated Risk had a huge post on this and still all smoke and no light for us peons.

I shall try and fail:

Hedge funds were "betting" that these MBS (mortgage backe securities) were not going to perform as expected. Once these MBS actually stopped performing rather than revalue them lower their owners "fixed them up" by various means. They did loan modifications and removed problem loans from the mix. This cost them money but not as much as if they had let the MBS deteriorate. The hedgis cry foul. "The plane would have crashed (and we would have colected the insurance) if the pilot hadn't intervened and steered the craft."

That help?

serinitis said...

Yes, Thanks

Fear The Murse said...

In response to the manufactured home comments on the last thread:
There are conforming lenders that will do them all day,even with vinyl skirting, BUT at 65% ltv max.

There are a few subprime lenders doing them up to 85% ltv (with cash out) depending on credit but most will not touch something with vinyl skirting - concrete block, brick, etc. required.

For a purchase, you better get them financed through your dealer unless you have a chunk to put down.

80/20's in general are still around. Sometimes you have to go to a specialized 2nd mtg lender to get the 100 ltv simultaneous close.

Holiday Inn said...

@Rob Dawg
If what you're saying is true (and I've heard it before), then I see major litigation ahead. An issuer of a derivative who fudges the price of the underlying asset will surely be sued by the counterparty. I can easily imagine contract, tort/fraud, and securities laws claims for a scheme like that. More money for lawyers.

The IB's made so much money from the tech IPOs in 1999-2000 that perhaps they looked at the multi-billion dollar settlements 5 years later as peanuts. They might have the same attitude today.

As always, the above is not any kind of professional advice. My name explains where I get the inspiration for my posts. Gotta go--recess is over.

(Ex) Train Wreck Watcher said...

@serinitis: "Could someone explain this for us simpletons a little better"

Let me try a slightly different tack than Rob. The hedge funds and the banks are in on an enormously complex financial game, where everyone has placed bets based on the highly variable flow of money from the gi-normous pool of mortgages, prime and sub-prime. The flow of money from those pools has started slowing down, and the banks are using all the "creative accounting" tricks in their playbook (and they've got a lot of them) to avoid paying up on losing bets.

There are two fundamental problems here, well, more than that. The biggest problem is that so many financial institutions booked profits from the mortgages before the money actually arrived. Now it turns out that not as much money is coming in as predicted, and as creative as our modern accounting is, at some point you have to put cash on the table, and the cash is not there.

The second big problem is that it turns out that there is very much of a zero-sum game going. As long as everyone could book their profits in advance, everyone could pretend that they were winning. Now that it comes time for cash payments on CDOs and MBSs and derivatives, not everyone has the money (see above), and it's rapidly becoming clear that the financial institutions are not "in it together", they are actually opposed, and one institution's gain is another's loss.

That's the reason the whole "Ponzi financing scheme" is in serious trouble--because we're in a capitalist society, and in a capitalist society everyone looks out for their own interests. The interests of the large financial institutions were mostly aligned on the way up, but are in direct conflict now that the real estate market (and with it the massive MBS market) is starting to turn down.

Tony Soprano said...

I just got done interviewing Loan Officer #1. Person flat out admitted to piggybacking buyers credit onto another with good credit. She said that within 60 days she can usually get a buyer up 100+ points! WOW! No wonder you hear so much about this loophole being closed. Didn't offer me the cash or FBSM though so they get the boot, NEXT!

I read Seattle Bubble daily. Lots of good stuff there especially in regards to Redfin.

Holiday Inn said...

'The hedgis cry foul. "The plane would have crashed (and we would have colected the insurance) if the pilot hadn't intervened and steered the craft."'

I'd say: the hedgies cry foul. "The ball would have stopped on red (and we would have collected our winnings) if the casino hadn't bribed the dealer to nudge the ball at the last second."

BJ said...

@Rob Dawg

Those that invest in high risk CDO/Mortgage backed securities often take out insurance to shield them from risk of non payment. It reduces their spread, but depending upon how the insurance rates the risk, it could be beneficial. It would be interesting to know who is the underwriter for said insurance. (Instrument is known as Credit Default Insurance). So important it even has a patent?

NOTE: That is my read from your statement. I would need a link to the actual Calculated Risk articl to work on it. I could not find it on his 'blogspot'

Tony Soprano said...

Hmmm, didn't CFC book Snowflakes $50,000 promissary note as profit? Think they've seen a payment?

Rob Dawg said...

{Ex} says;
The biggest problem is that so many financial institutions booked profits from the mortgages before the money actually arrived.

Okay. I will rephrase this s-l-o-w-l-y for troll crowd that should be gatting out of summer school about now.

Banks and other bank type lenders have been recording I/O, teaser rate and Neg-Am accruals as if they were real income. That means when the buyer is paying the first 6 months at 2% the bank is pretending this loan is current and actually paying the 8.25% on the note and that money is in their reserve balance. Scary.

"I will gladly pay you Tuesday for a hamburger today."

Rob Dawg said...

Tony,
Gee kangatard gets this "deal" and others don't? NFW. Countrywide is probably holding "foreclosureproof" promises by the wheelbarrow full.

I think there's a huge CFC shoe about to drop. So big that the PTB are concerned.

Tony Soprano said...

Dawg

The Tan Man has been awfully silent lately while he continues to cash out.....

Rob Dawg said...

Those that invest in high risk CDO/Mortgage backed securities often take out insurance to shield them from risk of non payment.

Those are the hedges were are discussing.

Vast tinfoil oversimplification follows:

Every big enough fund invests and insures and hedges against their investment and insurance and hedge positions. At every step of the way someone takes a cut. At this level of abstraction everyone loses except the bookies. "Trading Places."

Rob Dawg said...

The Tan Man has been awfully silent lately while he continues to cash out.....
As noted previously %20m in June alone. The "cone of silence" around CFC is deafening. [Does this count as a long overdue Sci-Fi reference?]

BJ said...

@Rob Dawg

You missed the statement.. I wonder who underwrote the insurance. Maybe the banks who are trying to adjust the traunch? The Credit Default Insurance articles are actually traded as well (Credit Default Swaps). What the proposed changes are doing is changing the profit profile between the CDOs vs its derivatives. Sacrificing the derivatives (Credit Default Swaps) to the benefit of the CDOs.

"Trading Places" was interesting, but a gross simplification of what goes on.. "Pepto-Bismol" at the ready!

Holiday Inn said...

"I wonder who underwrote the insurance. Maybe the banks who are trying to adjust the traunch?"

This is exactly it, though I wouldn't call it insurance. The banks trying to adjust the tranche are the issuers of the derivatives. That's the conflict of interest in Rob's heading.

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BJ said...

The Credit Default Swaps(CDSs) is exactly that, insurance of a specialized type (buyer pays a periodic fee in return for a contingent payment by the seller upon a credit event - ie default). Credit Default Swap articles can be traded separately from the item they are underwritten CDOs. What I find interesting is that the issuer of the CDO is adjusting the tranche. The issuer of the CDO is not always the same entity as the the underwriter for the CDS (conflict of interest issues there if they are).

Ie: I could pick up a CDO and an associated CDS to protect my earnings. If I feel that the money is safe, I could turn around and sell the CDS covering my CDO. The buyer of my CDS would continue payment in the hope that it would default.

Banks can underwrite the initial CDS and then sell the contract to someone else (who receives the payments but are obligated should the CDO go bad).

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Sprezzatura said...
This comment has been removed by the author.
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