Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [57]
These new entities seemed like corporations, but the only “business” they have is investing in assets and those assets have to provide “earnings.” Benjamin Graham’s disciples look for better quality of earnings and for earnings growth.
As the collateral in the structured investment vehicles inevitably took massive downgrades, the vehicles had to liquidate their wasting collateral, and investors lost a significant amount of their principal. Mutual funds, bank portfolios, insurance companies, local government funds, private investment groups, and more lost billions. Canadians heavily invested, and our North American neighbors lost billions. Since these assets carried high ratings, European and Asian investors also took losses.
Despite their “efforts,” investment banks were still stuck with tens of billions of unsold CDOs. They reduced exposures by buying bond insurance, buying credit protection from hedge funds, and doing a variety of leveraged sales. Some of that risk boomeranged back onto bank balance sheets.
The madness did not stop with mortgage loans. Collateralized debt obligations can be backed by any combination of debt: credit derivatives, asset-backed securities, mortgage-backed securities, other collateralized debt obligations, hedge fund loans, credit card loans, auto loans, bonds, leveraged corporate loans, sovereign debt, or any kind of combination of actual or notional debt man can imagine and create.
Stephen Partridge-Hicks, co-head of Gordian Knot, probably the best run structured investment vehicles in the world, felt the effects of a nervous market reluctant to invest in the debt of any investment vehicle. Risky overrated AAA commercial paper issued by risky structured investment vehicles caused investors to shun sound investments. He told me he bought zero subprime-backed investments and rejected a lot of other misrated AAA deals.Yet shortly after Lehman’s bankruptcy, Sigma, one of his two funds, collapsed.
If I had a large bonus in my sights and mischief on my mind, how would I unload toxic CDO tranches? This is all hypothetical, mind you, but here’s just one of a number of different gimmicks.
If you work at an investment bank and you stuff the toxic tranches of only your own CDOs into another CDO, it will be too obvious.You need help from your friends who work for other investment banks, hedge funds, and CDO managers. Since you all have toxic CDOs and still want to earn high fees, you can all play investment banking hawala similar to the complex, but highly effective, money brokering system used in the Middle East. Hawala makes it virtually impossible to trace cross-border money flows. It will be hard for anyone, except the SEC or someone with subpoena power to examine your trade tickets, to figure out what you are doing. Since the SEC seems to have lost its will to exist, you are good to go.
There is just one more thing. As Warren told me at lunch, many people seem to have a perverse desire to make things overly complicated. Yet, the fundamentals of finance do not change. Most value investors will not be fooled, and they actually read your documents. If you really think you can confuse unwary investors about the basics by hiding behind a label such as “synthetic CDO-squared,” you are good to go.
Mix your toxic junk with your friends’ toxic junk into a CDO-SQUARED. Now you have deniability. After all, why would you buy someone else’s CDOs if they were toxic? Now get the compliant rating agencies to rate a huge chunk of this risky hairball triple A. If you are lucky, you may find an investor to buy it. Failing that, you may find a bond insurer to insure it. Failing that, you may find an investment vehicle or hedge fund willing to do a credit derivative or other leveraged transaction.These diversions should get you through bonus season. After all else fails, your investment banks can beg the Federal Reserve Bank to take overrated AAA paper in