Bish, Bosh, Loads of Dosh!
by Adrian Ash
BullionVault
Tuesday, 17 July 2007
"...Wasn't Bear Stearns supposed to report the losses at its two mortgage-bond hedge funds on Monday this
week...?"
"BEAR STEARNS Investors Await Tally on Losses," said the Wall Street Journal two weeks ago. The two-week
deadline, set by America's fifth-largest securities firm itself in an email to investors, came and went yesterday.
So far, no news from Bear Stearns, nor from the WSJ. No news either from the co-chief executive officer and
director of the two funds in question. Which is odd. For Ralph Cioffi did so love to talk!
The High-Grade Structured Credit Strategies Fund and its heavily-geared cousin, the High-Grade Structured
Credit Strategies Enhanced Leverage Fund, have been run by Cioffi since 2003, a true pioneer of the credit
derivatives market. He was still talking up the potential for leveraging debt upon debt as recently as February this
year, even telling a bond conference in New York that "we're looking at somewhat immature markets that are
going through a growth phase. There is a catharsis and a cleaning-out process."
But today? Not a sausage. Maybe Cioffi's too busy with catharsis...or perhaps cleaning out.
Why the delay, you might ask, in pricing the alphabet soup that Cioffi first began to develop in the early 1990s?
Maybe the difficulty in pricing these assets has got something to do with the way they were created. To quote the
man himself, from an interview with Wall Street & Technology in August 2005:
"In the dealer-to-customer market [for credit default swaps], traders mostly construct contracts over the phone
and via Bloomberg e-mails. Transaction and settlement records are created through a good deal of cutting and
pasting of documents, and confirmations sometimes do not arrive for as long as 90 days."
Bish, bosh, loadsadosh! Ninety-day settlement for a cut-and-paste job created on the fly over the phone. Any
wonder Cioffi's team are having trouble putting a price on the collateralized debt obligations (CDOs) built upon
just this kind of credit default swap two years later?
"When we execute via Bloomberg," Cioffi went on, "we have to notify our back office through an e-mail, we
calculate the settlement amount, the dealer sends us the amount and then we notify the buyer or seller of
protection, so there are a number of steps."
A number of steps, eh? This non-standard and seemingly haphazard process was employed before the tech'
team moved in and enabled trading in credit defaults to balloon. In the US, Bear Stearns' credit default traders
were early adopters of MarketAxess, run off the DTC's own CDS matching service. Now, with trading in credit
derivatives running at twice the volumes of only two years ago according to Fitch Ratings, "there is plenty of room
for shocks ahead," reckons Harald Malmgren, an economic consultant in Washington.
"Volatility is coming back to the market. We could see crack-ups of some household names."
Could Bear Stearns be the first household name to crack up? It doesn't seem likely, not with the rest of Wall
Street willing to step up and cover the two hedge funds' embarrassment. Back at the start of July, however, the
bank said it might take until yesterday – July 16th – to price up the junk littering its mortgage-derivative funds,
because "in light of the Funds' circumstances, this process is more time-consuming than in prior periods."
In other words, Bear Stearns didn't have a clue how much money it had lost. Nor would you if you had sunk all
your money – or rather, all your clients' money – in CDOs built upon CDSs reckoned against MBSs based on
mortgage loans made to people with no hope of making their monthly repayments.
More worrying still for the Fed, the SEC, and their fellow regulators in Europe – where credit hedge funds in
London and Milan have already hit trouble, too – Bear Stearns was at least present when these monsters were
born. Much of the evil afterbirth, the ultra-high risk credit derivatives that the investment banks wanted to sell on,
has wound up in pliant and placid institutional funds instead.
Indeed, your own retirement and insurance funds may perhaps have become investment landfill for some of this
toxic waste. And again, little secret was made of the trouble ahead back in summer 2005:
"Critics fear the explosive growth in CDOs could spell trouble for Wall Street, since many of the institutional
investors buying them are not fully aware of what they're biting into," wrote Matthew Goldstein for TheStreet.com
nearly two years ago. "To compound matters, independent pricing information about these specialized bonds is
hard to come by. With a limited secondary market for trading CDOs, buyers often must rely on the Wall Street
firms that underwrite them for an idea on what they're worth."
In particular, "All of Wall Street may come to rue the day Bear Stearns sold $16 million in collateralized debt
obligations to Hudson United Bank," Goldstein reported. "The sale prompted a complaint to New York Attorney
General Eliot Spitzer from Hudson United, which believes Bear Stearns gave it bad prices on the sophisticated
bonds."
Bad prices on entry look certain to be awful on exit. The fact that yesterday came and went without any news
from Bear Stearns itself suggests that Cioffi remains clueless at best about the real value of the mortgage-
backed derivatives his funds are still holding. Starting right back at the beginning, with the underlying mortgages
themselves, might now be the only route left.
Mortgage-backed securities, credit default swaps, collateralized debt obligations, synthetic CDOs...even in
something like plain English, none of these assets is liquid or tradable in the way that an equity or a 400-ounce
bar of investment-grade gold is tradable. Each of these cut-and-paste jobs, in contrast, represents something
approaching a legal contract packed full of sub-clauses and waivers – and judging the value of legal agreements
at speed is a long way from simply "marking to market" a portfolio of liquid securities.
"Mark to model is a joke," says Janet Tavakoli, head of Tavakoli Structured Finance, a consulting firm in Chicago.
"What you need to do now is vet the underlying collateral," she says – meaning the underlying mortgage debt.
"It's grubby, roll-up-your-sleeves kind of work," says Tavakoli – and it's all so very different from the easy, click of
a mouse work done by Cioffi and Bear Stearns when they first piled into the mortgage-bond derivatives market.
Adrian Ash
BullionVault
Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine,
Adrian Ash is the editor of Gold News and head of research at BullionVault – where you can buy gold today
vaulted in Zurich on $3 spreads and 0.8% dealing fees.
(c) BullionVault 2007
Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your
money, and any decision you make will put your money at risk. Information or data included here may have
already been overtaken by events – and must be verified elsewhere – should you choose to act on it.
by Adrian Ash
BullionVault
Tuesday, 17 July 2007
"...Wasn't Bear Stearns supposed to report the losses at its two mortgage-bond hedge funds on Monday this
week...?"
"BEAR STEARNS Investors Await Tally on Losses," said the Wall Street Journal two weeks ago. The two-week
deadline, set by America's fifth-largest securities firm itself in an email to investors, came and went yesterday.
So far, no news from Bear Stearns, nor from the WSJ. No news either from the co-chief executive officer and
director of the two funds in question. Which is odd. For Ralph Cioffi did so love to talk!
The High-Grade Structured Credit Strategies Fund and its heavily-geared cousin, the High-Grade Structured
Credit Strategies Enhanced Leverage Fund, have been run by Cioffi since 2003, a true pioneer of the credit
derivatives market. He was still talking up the potential for leveraging debt upon debt as recently as February this
year, even telling a bond conference in New York that "we're looking at somewhat immature markets that are
going through a growth phase. There is a catharsis and a cleaning-out process."
But today? Not a sausage. Maybe Cioffi's too busy with catharsis...or perhaps cleaning out.
Why the delay, you might ask, in pricing the alphabet soup that Cioffi first began to develop in the early 1990s?
Maybe the difficulty in pricing these assets has got something to do with the way they were created. To quote the
man himself, from an interview with Wall Street & Technology in August 2005:
"In the dealer-to-customer market [for credit default swaps], traders mostly construct contracts over the phone
and via Bloomberg e-mails. Transaction and settlement records are created through a good deal of cutting and
pasting of documents, and confirmations sometimes do not arrive for as long as 90 days."
Bish, bosh, loadsadosh! Ninety-day settlement for a cut-and-paste job created on the fly over the phone. Any
wonder Cioffi's team are having trouble putting a price on the collateralized debt obligations (CDOs) built upon
just this kind of credit default swap two years later?
"When we execute via Bloomberg," Cioffi went on, "we have to notify our back office through an e-mail, we
calculate the settlement amount, the dealer sends us the amount and then we notify the buyer or seller of
protection, so there are a number of steps."
A number of steps, eh? This non-standard and seemingly haphazard process was employed before the tech'
team moved in and enabled trading in credit defaults to balloon. In the US, Bear Stearns' credit default traders
were early adopters of MarketAxess, run off the DTC's own CDS matching service. Now, with trading in credit
derivatives running at twice the volumes of only two years ago according to Fitch Ratings, "there is plenty of room
for shocks ahead," reckons Harald Malmgren, an economic consultant in Washington.
"Volatility is coming back to the market. We could see crack-ups of some household names."
Could Bear Stearns be the first household name to crack up? It doesn't seem likely, not with the rest of Wall
Street willing to step up and cover the two hedge funds' embarrassment. Back at the start of July, however, the
bank said it might take until yesterday – July 16th – to price up the junk littering its mortgage-derivative funds,
because "in light of the Funds' circumstances, this process is more time-consuming than in prior periods."
In other words, Bear Stearns didn't have a clue how much money it had lost. Nor would you if you had sunk all
your money – or rather, all your clients' money – in CDOs built upon CDSs reckoned against MBSs based on
mortgage loans made to people with no hope of making their monthly repayments.
More worrying still for the Fed, the SEC, and their fellow regulators in Europe – where credit hedge funds in
London and Milan have already hit trouble, too – Bear Stearns was at least present when these monsters were
born. Much of the evil afterbirth, the ultra-high risk credit derivatives that the investment banks wanted to sell on,
has wound up in pliant and placid institutional funds instead.
Indeed, your own retirement and insurance funds may perhaps have become investment landfill for some of this
toxic waste. And again, little secret was made of the trouble ahead back in summer 2005:
"Critics fear the explosive growth in CDOs could spell trouble for Wall Street, since many of the institutional
investors buying them are not fully aware of what they're biting into," wrote Matthew Goldstein for TheStreet.com
nearly two years ago. "To compound matters, independent pricing information about these specialized bonds is
hard to come by. With a limited secondary market for trading CDOs, buyers often must rely on the Wall Street
firms that underwrite them for an idea on what they're worth."
In particular, "All of Wall Street may come to rue the day Bear Stearns sold $16 million in collateralized debt
obligations to Hudson United Bank," Goldstein reported. "The sale prompted a complaint to New York Attorney
General Eliot Spitzer from Hudson United, which believes Bear Stearns gave it bad prices on the sophisticated
bonds."
Bad prices on entry look certain to be awful on exit. The fact that yesterday came and went without any news
from Bear Stearns itself suggests that Cioffi remains clueless at best about the real value of the mortgage-
backed derivatives his funds are still holding. Starting right back at the beginning, with the underlying mortgages
themselves, might now be the only route left.
Mortgage-backed securities, credit default swaps, collateralized debt obligations, synthetic CDOs...even in
something like plain English, none of these assets is liquid or tradable in the way that an equity or a 400-ounce
bar of investment-grade gold is tradable. Each of these cut-and-paste jobs, in contrast, represents something
approaching a legal contract packed full of sub-clauses and waivers – and judging the value of legal agreements
at speed is a long way from simply "marking to market" a portfolio of liquid securities.
"Mark to model is a joke," says Janet Tavakoli, head of Tavakoli Structured Finance, a consulting firm in Chicago.
"What you need to do now is vet the underlying collateral," she says – meaning the underlying mortgage debt.
"It's grubby, roll-up-your-sleeves kind of work," says Tavakoli – and it's all so very different from the easy, click of
a mouse work done by Cioffi and Bear Stearns when they first piled into the mortgage-bond derivatives market.
Adrian Ash
BullionVault
Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine,
Adrian Ash is the editor of Gold News and head of research at BullionVault – where you can buy gold today
vaulted in Zurich on $3 spreads and 0.8% dealing fees.
(c) BullionVault 2007
Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your
money, and any decision you make will put your money at risk. Information or data included here may have
already been overtaken by events – and must be verified elsewhere – should you choose to act on it.