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By Root 773 0

between the investors, Credit Suisse Alternative Capital (CSAC), and other Credit Suisse affiliated entities, including the Leveraged Investment Group (LIG) of Credit Suisse Securities (CSS).10 I always recommend that investors eliminate this kind of moral hazard by insisting on changes to the deal. Conflicts of interest do not mean that there is anyone doing anything wrong, but when the moral hazard is enormous, things never seem to end well for investors. Rating agency models do not capture these huge risks, yet, the rating agencies never seem to refuse to rate these deals. I have written books and articles on this problem for years; the ratings on deals with this kind of risk are totally meaningless. Yet the rating agencies continue to defend their indefensible methods.

Among many classes of bad deals, the problems of CDOs named after constellations were well publicized. Approximately $35 billion of these CDOs had been underwritten by Citigroup, UBS, Merrill Lynch, Calyon, Lehman, and others.They are mostly fallen stars. I told the Wall Street Journal that Norma, a Merrill-underwritten CDO comprised mostly of credit derivatives linked to BBB rated tranches of other securitizations, “is a tangled hairball of risk.”11 It had come to market in March 2007, and by December 2007, it was worth a fraction of its original value. The rating agencies slashed its ratings to junk. I added “[A]ny savvy investor would have thrown this…in the trash bin.”12

Constellation deals were not the only class of dicey deals, and it seems that CDOs bought in the last half of 2006 and during 2007 were particularly awful. Investment banks found they had a huge credibility problem with investors. Merrill Lynch was not alone in having credibility problems, but I happened to review all of their 2007 CDOs that I could track. I looked at 30 CDOs and CDO-squared deals with a notional amount of $32 billion that Merrill Lynch underwrote in 2007. As of June 10, 2008, all of the deals I captured were in trouble at the AAA level. One or more of the originally AAA rated tranches had been downgraded to junk (below investment grade) by one or more rating agencies. Merrill Lynch was not alone in having a poor track record, but this sort of unprecedented performance was hard to beat. CDO managers had nothing to be proud of, either, and many saw their streams of fee income dwindle.The securitization market was in a dead calm.13 I made my concerns public.1415 As far as I was concerned, the Hall of Shame looked overcrowded. Losing trust was not the only problem. Financial institutions lost hundreds of billions of dollars.

Bloomberg keeps daily tabulations of subprime related losses worldwide. I told Yalman Onaran that although some mark-to-market losses may be reversed as markets recover, most of the losses are permanent impairments caused by surging defaults: “[O]f course we can’t tell how much . . . may actually be good stuff that will pay back at maturity.”16

By June 18, 2008, Bloomberg estimated that global bank balance sheet losses due to write-downs and charge-offs at $396 billion. That figure may have been tainted with denial. By October 16, 2008, it nudged past $660 billion. Citigroup had written down $55.1 billion, Merrill Lynch $58.1 billion, and UBS $44.2 billion. Wachovia topped the list with losses of $96.7 billion; Washington Mutual’s losses were $45.6 billion. The list was long and sobering.1718 Risky loans made to both risky borrowers and prime (high credit score) borrowers were only part of the problem. Predatory securitizations amplified losses. As a result, the entire landscape of global investment banking changed.

The damage to the global markets was much worse, however. Losses reported by the banks do not include losses to hedge funds, private equity investors, mutual funds, municipalities, insurance companies, pension funds, and more.The International Monetary Fund (IMF) estimates losses related to the U.S. subprime meltdown and its fallout could reach about $1 trillion.19

I blurted out to Warren that I was disgusted with the “douche bags