ABCP's of stealing $32 Billion. Case study 2 for inquiry

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Credit crisis 'made in Canada'
Lax Rules Blamed

Duncan Mavin and john Greenwood
National Post, With Files From Sean Silcoff; National Post



Thursday, September 27, 2007

CREDIT: Brent Foster/National Post
Coventree Capital is pictured in Toronto, Ontario Tuesday September 18, 2007.

Canadian banks are struggling to contain a credit crisis that could spiral out of control here more than it has elsewhere because of a lax regulatory regime, sources have told the National Post.

The crisis relates to the market for a complex type of short-term funding known as asset backed commercial paper (ABCP), which had grown out of proportion in this country partly thanks to Canadian rules that were not as tough as in other nations.

"It's a made-in-Canada problem," said Claude Lamoureux, head of Ontario Teachers' Pension Plan. Many people in the market "didn't know or didn't ask questions" because they were making more profits than elsewhere, he added.

The Canadian ABCP market attracted a flood of foreign financial institutions such as Barclays Bank and Deutsche Bank, who exploited the gaps in the Canadian ABCP rules to make big profits at lower risk to themselves, sources said.

"They were effectively able to earn fees from supplying liquidity without ever having to supply the liquidity or set aside capital," said a source.

In the worst-case scenario, if global financial players lose confidence in the Canadian ABCP system altogether, the crisis could spread to Canada's big banks, leaving them on the hook for tens of billions of dollars.

ABCP is a package of debt obligations -- anything from car loans to credit-card debt. The product grew in popularity in recent years among everyone from pension funds to corporate treasury departments to banks because ABCP offered higher returns than, for example, a corporate bond or treasury bill.

Typically, ABCP products also involve liquidity support from a supplier, usually a major bank. In simple terms it is an agreement to buy the ABCP in the event of a disruption to the market.

In Canada, the market grew more quickly than in other countries, doubling between 2000 and 2007 to $120-billion, because the Canadian definition of disruption to the market was much narrower than elsewhere.

In Canada, liquidity suppliers did not have to provide funding except in catastrophic circumstances.

Also the Canadian banking regulator, unlike regulators in other countries, did not ask the liquidity supplier -- the bank -- to set aside any capital, so they could use it to grow other lines of business.

"ABCP growth outstripped traditional personal and commercial loan growth," and was "meaningfully above the pace of U.S. ABCP market expansion," said Blackmont Capital banking analyst Brad Smith.

In addition, Canadian debt rating agency Dominion Bond Rating Service gave a rating to Canadian ABCP even though other rating agencies such as Moody's and Standard & Poors shied away from doing so.

By June this year, Canada's ABCP market was about 10% of the size of the market in the United States, although the overall U.S. financial system is proportionately far larger than Canada's.

When concerns surfaced in August about the underlying assets in ABCP -- many of which have included troubled mortgage loans in the U.S. -- some owners of ABCP were caught off guard. Owners of ABCP were under the belief that they could convert it to cash or another similar product at the end of 30 or 60 days but instead were left holding the product.

Canadian investment bank Coventree Capital Inc. became one of the first major victims of the global credit crunch when it was unable to trade the ABCP it was holding because of the general seizing up of credit markets around the world.

Following Coventree's collapse, Canadian non-bank owners of $40-billion of troubled asset-backed commercial paper -- pension funds and corporate treasury departments -- were forced into an unprecedented joining-of-forces known as the Mont-real Accord to try to salvage their holdings.

If the Montreal Accord does not result in a long-term agreement on how to resolve the issues in Canada's non-bank ABCP market by an Oct. 15 deadline, there could be a carryover effect on the demand generally for ABCP, said Blackmont's Mr. Smith.

"Failure to fully restore investor confidence levels could reduce demand ...which could restrict the future ability of banks to manage capital," he said.

Mr. Smith calculated that Canada's big six banks are on the hook for total liquidity facilities worth $135-billion.

Canada's bank regulator -- the Office of the Superintendent of Financial Institutions -- did not return calls from the National Post seeking comment for this story. However, in an e-mail the regulator indicated that the rules enforced in Canada were in accordance with international guidelines.

HOW IT WORKS

▌A bank packages a collection of mortgages, credit card balances, or lines of credit into an ABCP that matures in 30 days.

▌The bank sells ABCP for a fee to an intermediary that assumes all the risk associated with the underlying assets.

▌The intermediary sells pieces of the ABCP to investors, including pension funds or corporations or individuals.

▌Investors are paid interest and assume there will be a buyer for their piece of the ABCP after 30 days.

▌For a fee, the bank supplies funds to buy the ABCP if there are no other buyers

▌in Canada, this feature did not work in August when investors could not find a buyer.

© National Post 2007


(advocate comments.........another example of financial purveyors selling "knowingly tainted" product into the Canadian marketplace, because typically there is no consequence for doing so)

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Another Made-in-Canada Defective Investment Product
Pensioners, Taxpayers and Shareowners Bear Loss on Defective Commercial Paper
Prepared By: Diane Urquhart, Independent Analyst
Updated October 2, 2007
Summary
$4 billion to $20 billion is the expected loss on another Made-In-Canada defective
investment product - Third Party Asset Backed Commercial Paper (Third Party ABCP).
Pension beneficiaries, taxpayers and shareowners will bear this loss on the defective
commercial paper held by government and corporation pension funds and treasuries.
The $40 billion Third Party ABCP is a Made-in-Canada defective investment product,
mainly because it has Made-in-Canada liquidity agreements. Canadian liquidity
agreements were below international standard and contained provisions that allowed
banks to walk away from calls for cash to repay the Canadian Third Party ABCP owners,
who wanted their cash back on the maturity date, usually 30 to 90 days after purchase.
Dominion Bond Rating Services (DBRS) bears significant responsibility for giving false
top credit ratings on the ABCP that did not meet the international standard for liquidity
agreements, nor any of the other five basic investment axioms listed in this report. Other
international credit rating firms, and especially Standard & Poors Canada, would not rate
the Canadian paper, let alone give it a top credit rating. On September 12, 2007, DBRS
announced it was moving to the international standard for liquidity agreements.
The Federal Office of the Superintendent of Financial Institutions (OSFI) Regulation B-5
permitted the banks to sign what I call the "Made-in-Canada" defective liquidity
agreements for the Third Party ABCP. The banks did not need to assign capital for their
obligations under the Canadian standard liquidity agreements, because these liquidity
agreements were of no use and would almost never lead to bank back-up payments to the
ABCP owners. As such, OSFI has assisted the banks to skim fees from the ABCP
conduits, which reduced the interest paid to the retail investors, Canadian pension funds
and corporations owning ABCP.
The Third Party ABCP market effectively froze in August 2007, when Canadian
investors were no longer willing to buy the CP, due to their increased awareness of its
potential for loss. If banks walking away from liquidity agreements was not enough of a
problem, there is widespread ownership of credit default swaps within the conduits,
where counterparties have the right to make margin calls for more cash to be added to the
conduits, and to lay claim to the collateral of quality assets in the conduit. The owners of
the Third Party ABCP would naturally have assumed that the quality assets in the conduit
were exclusive collateral to their own loans to the conduit. Credit default swaps are not
covered in the Canadian Companies' Creditor Arrangement Act, so the restructuring
proposals are not subject to court management.
2
The rights of the banks in the credit default swaps to call margin and to claim collateral
refutes the hope of no losses on the Third Party ABCP in both the short and the long term
for the group of conduits, as a whole. The banks that are counterparties to the credit
default swaps are the same banks who signed the defective liquidity agreements in most
of the problem conduits. These bank put themselves into the powerful position of being
able to make a call for cash to pay for default damages under their swap, knowing that
they would walk from their liquidity agreements and gain access to the
conduit's collateral of top rated assets held in trust. These bank counterparties had the
control to trigger the crisis for the Third Party ABCP owners in Canada.
This time it is the investment banks' preferred government and corporation customers that
are losing money on what they understood to be a very low risk place to park cash. Retail
investors, still reeling from the capital losses caused by financial reporting deceptions in
income trusts, are largely spared from the pending damages in Third Party ACPB, as this
is not a retail product.
Canadian beneficiaries of pension plans and the shareowners of crown corporations and
corporations bear the loss from the defective Third Party ABCP. The professional money
managers buying the defective paper were negligent in their due diligence, or they were
deceived by the Third Party ABCP sponsors, bank credit default swap counterparties and
liquidity agreement signatories, investment bank distributors and/or DBRS.
There were substantial risk premium dollars within the Third Party ABCP structures to
cover the liquidity, default and leverage risks. However, the Third Party ABCP sponsors,
bank credit default swap counterparties and liquidity agreement signatories and
investment bank distributors took most of the risk premium for themselves in fees and
profits, while the owners of the Third Party ABCP only got 5 to 10 basis points. The
vendor group took most of the risk premium, even though they must have known they
shifted all of the risk to the owners through limited use liquidation agreements and credit
default swaps making owners pay for leveraged default damages.
The Montreal Accord Group and Purdy Crawford's Pan Canadian Committee of Investors
in Third Party ABCP cannot make the pension funds, crown corporation and private
sector corporation treasuries whole. The members of the Montreal Accord Group are
primarily the banks/investment banks who are the credit default swap counterparties,
liquidity agreements signatories or distributors of the defective investment product. The
members of the Pan Canadian Committee include senior management of the government
pension funds and crown corporation treasuries who bought the defective paper. There is
one corporation owner represented on the Group or Committee.
Both the Montreal Accord Group and the Pan Canadian Committee are highly motivated
for a quick and opaque solution, since they are vendors, who were either negligent or
intended to deceive the buyers; or, they are professional buyers, who were either
negligent, or deceived by the vendor group.
3
The Federal Parliament, through the Federal Minister of Finance, must appoint a
qualified independent monitor to ensure that the interests of the pension
beneficiaries, taxpayers and shareowners are met. It is not suffice that Purdy
Crawford will be guided by his own views as to fairness, since he is employed by the Pan
Canadian Committee, whose members are more concerned about their personal
reputations and jobs than the loss to be borne by the pension beneficiaries, taxpayers and
shareowners.
Third Party ABCP is another Made-in-Canada defective investment product that
demonstrates there is no investor protection for investors and pensioners in Canada.
Craig Hannaford and Bill Majher, former RCMP white collar crime investigators,
say in Canadian Business on September 24, 2007, "The system is pretty much nonexistent."
No one stops defective investment products in Canada; no one answers
911 calls from Canadians suffering losses on defective investment products; and
those responsible for the defects are allowed to create closed shop restructuring
solutions at the expense of average Canadians.
Another Made-in-Canada Defective Investment Product................................................... 1
Pensioners, Taxpayers and Shareowners Bear Loss on Defective Commercial Paper....... 1
Summary ............................................................................................................................. 1
Investment Axioms Not Followed in Canada's Third Party ABCP.................................... 4
Banks Have Different Treatments for Different ABCP Owners ........................................ 5
Who are the Vendors of Third Party ABCP?...................................................................... 6
Who Bears the Loss From Made-in-Canada Defective Commercial Paper? ..................... 8
The Workout Process........................................................................................................ 10
Not a Controllable Situation Since Credit Default Swaps Not Covered By the
Companies' Creditor Arrangement Act............................................................................. 11
Office of Superintendent of Financial Institutions Permitted Defective Liquidity
Agreements ....................................................................................................................... 13
The Pan Canadian Committee Cannot Make the Pension Beneficiaries, Taxpayers and
Shareowners Whole .......................................................................................................... 15
Urgent Changes Needed in the Workout Process ............................................................. 16
A Final Word on Where Are the Securities Regulators?.................................................. 18
4
Investment Axioms Not Followed in Canada's Third Party ABCP
1. ABCP bank liquidity agreements cannot have general ABCP market disruption or
diminished asset creditworthiness loopholes, if liquidity risk and default risk is to
be eliminated. This is the international standard for liquidity agreements, before
ABCP receives a top investment rating from international credit rating agencies.
2. Funding long term assets with short term commercial paper causes high liquidity
risk.
3. ABCP owning sub prime mortgages has default risk since sub prime mortgage
borrowers having a high probability of not being able to meet their interest
payments.
4. ABCP containing derivatives, that are untested in different economic
environments, is risky. Derivatives not used for hedging do not belong in
commercial paper, that owners regard to be almost risk free.
5. Not knowing how the investment product vendors share the investment returns
and risks usually puts you at the short end of the bargain. Credit default swaps
are said by insiders to have been added to the ABCP to boost the yields above the
no risk return of T-bills. But, the conduit owners and bank suppliers and
distributors took the lion's share of the boosted yield, even though they knew the
owners were ultimately responsible for all of the liquidity and default losses, and
not them.
a) In a credit default swap, the seller is obliged to pay for the default losses
on credit he does not own. The buyer of the credit default swap pays
premiums to the seller, which the seller uses to fund his future obligation
to pay for credit losses. But these premiums prove to be insufficient if the
default damages are higher than expected. Consequently, the marked to
market valuations of credit default swaps can be volatile, even when the
risk of default at the levels defined in the contract seem remote at the time
the contract was entered into. Credit default swap counterparties have
right to call for additional margin and to lay claims to collateral.
b) Even if there is just 5 to 10 basis points higher return over risk free
alternatives, ask questions about the risk and what's in it for the vendors.
6. Adding leverage to boost investment returns always adds risk, when conditions
deteriorate. In the ABCP, the credit default swaps were in dollar amounts that
were 10 to 20 times more than the amount invested in the ABCP, so that even a
modest adverse change in marked to market credit default swap prices leads to
serious % capital loss on the ABCP investment.
5
Banks Have Different Treatments for Different ABCP Owners
Figure 1 shows that Canada's total money market is $360 billion, of which 32% is risk
free government treasury bills. The ABCP component of the money market is 32% or
$115 billion. ABCP has two types: Bank ABCP and Third Party ABCP. Bank ABCP is
issued by conduits manufactured and distributed by the major banks or their wholly
owned investment banks. Third Party ABCP, on the other hand, is issued by conduits
manufactured by the 5 non bank financial corporations named in Figure 2. The Third
Party sponsored conduits were distributed by the major investment banks to Canada's
investing clients. It was the $40 billion Third Party ABCP that effectively froze in
August 2007, when owners of the Third Party ABCP asked for their money back and the
foreign banks who were the signatories to the liquidity agreements backing this paper
refused a call for funds because conditions for the call were not met.
On August 20, 2007, four days after signing the Montreal Accord, the National Bank of
Canada announced it is acquiring $1.85 billion of Third Party ABCP, held in National
Bank and affiliate mutual funds, pooled funds or direct brokerage accounts of its retail
clients and of any corporations clients, who hold $2 million or less of ABCP in their
accounts, and who do not qualify as accredited investors under securities regulations.
Government and corporation pension funds and treasuries fall under the definition of
accredited investors under provincial securities laws, so these are not being reimbursed
by National Bank for expected damages.
The other major banks have announced their intent to guarantee the buyback of their own
Bank ABCP. These other major banks have also volunteered to indemnify losses for
Third Party ABCP held in their own mutual funds. However, retail brokerage clients who
purchased Third Party ABCP directly or in trust securities, like the Global Diversified
Investment Grade Trusts I and II, have not received voluntary offers to cover their
damages. The government and corporation pension funds and treasuries, that are
accredited investors, who bought the Third Party ABCP from the institutional money
market desks will also not be compensated by the other major banks.
Banks volunteering compensation to the retail mutual fund owners is likely due to their
conflicts of interest in making fees from both distributing the Third Party ABCP and from
management of the mutual fund. The bank owned mutual fund portfolio managers have a
duty to select securities that maximize performance in the interest of the mutual fund
unitholders. Retail brokerage clients purchasing Third Party ABCP directly are owed a
duty of care by their financial advisors, and so a case can be made for them to also
receive voluntary compensation.
The sophisticated institutional and corporation clients, who bought Third Party ABCP,
are expected to do their own homework and not to trust their investment bank or credit
rating agencies, when Third Party ABCP is marketed to be top investment grade and safe.
The sophisticated institutional and corporation clients can only expect successful
litigation and restitution, if there is misrepresentation or fraud in the information
memorandum or credit rating, or there is negligence on the part of the sponsors,
investment banks, or DBRS.
6
Figure 1: Canada's Money Market ByType of Security
Who are the Vendors of Third Party ABCP?
Figure 2 summarizes names from the Information Memorandum for the 23 problem
conduits at http://research.cibcwm.com/commercialpa ... cp_i.shtml . The
sponsors of the Third Party ABCP conduits are: Coventree Capital Group, Dundee
Securities, Metcalfe & Mansfield Alternative Investments, Nereus Financial (a wholly
owned subsidiary of Coventree Capital Group), Newshore Financial Services and
Securitus Capital. The original distribution agents shown in Figure 2 are BMO, CIBC
World Markets, Desjardins Bank Securities, Deutsche Bank Securities, HSBC Securities,
Laurentian Bank Securities, National Bank of Canada, RBC Dominion, Scotia Capital
and Société Générale Securities. The underlined distribution agents are not on the
Montreal Accord Group and Pan Canadian Committee.
Every investment bank operating an institutional money market desk would have been
executing trades in the 23 problem conduits with their pension fund, corporation and
government clients.
There were just three legal firms who provided the legal services to the 23 problem
conduits: Davies, Ward Phillips & Vineberg, McCarthy Tetrault and Ogilvie Renault.
7
Figure 2: Third Party ABCP Sponsors & Distributors
Trust Names Securitization Agents
Liquidity Agreements/
Credit Default Swaps Distribution Agents Legal Counsel
Information Memorandum
Coventry Capital Group Inc.
Dundee Securities
Metcalfe & Mansfield Alternative Inv
Nereus Financial Inc.
Newshore Financial Services Inc.
Securitus Capital Corporation
ABN Ambro
Barclays Bank
Deutsche Bank
HSBC Bank
UBS
BMO
BNP Parabas
CIBC World Markets
Desjardins Securities
Deutsche Bank Securities
HSBC Securities
Laurentian Bank Securities
National Bank of Canada
RBC Dominion
Scotia Capital
Societe Generale Securities
Davies Ward Phillips & Vineberg
McCarthy Tetrault
Ogilvie Renault
√ Apollo Trust 1 1 1 1 1 1
√ Apsley Trust 1 1 1 1 1 1 1 1
Aria Trust 1
√ Aurora Trust 1 1 1
√ Comet Trust 1 1 1 1 1 1
DBRS Devonshire Trust 1 1 1
Encore Trust 1
√ Foundation Trust 1 1 1 1 1 1
√ Gemini Trust 1 1 1 1 1 1
√ Ironstone Trust 1 1 1
MMAI-I Trust 1 1
Newshore Canadian Trust 1
√ Opus Trust 1 1 1 1 1 1 1 1 1
√ Planet Trust 1 1 1 1 1 1 1 1
√ Rocket Trust 1 1 1 1 1
√ Selkirk Funding Trust 1 1 1 1 1
√ Silverstone Trust 1 1 1 1 1 1 1 1
√ Skeena Capital Trust 1 1 1
√ SLATE Trust 1 1 1
√ Structured Asset Trust 1 1 1 1 1
√ Structured Investment Trust III 1 1 1 1 1
√ Symphony Trust 1 1 1 1 1 1 1 1 1
√ Whitehall Trust 1 1 1 1 1
8
Who Bears the Loss From Made-in-Canada Defective Commercial Paper?
Figure 3: Third Party ABCP Publicly Disclosed Owners
9
10
The Workout Process
On August 16, 2007, the Caisse de dépôt et placement du Québec brokered an agreement
amongst eight banks/investment banks and PSP Investments (Federal Public Service
Pension Plan) to a 60 day moratorium on owners calling default of the Third Party Paper
ABCP and on contract parties making margin calls and liquidity agreement calls.
Participants are seeking an extension of this moratorium, as announced on September 27,
2007. The signatories, to what became known as the Montreal Accord, are developing
detailed restructuring plans for the affected Third Party ABCP. The restructuring is
expected to involve the conversion of the short term ABCP into long term notes with
floating interest rates. The owners seeking to realize cash in the short term will likely
receive a purchase offer for these new notes brokered by one or more of the
banks/investment banks within the Montreal Accord group.
On September 6, 2007, the Pan Canadian Committee for Investors in Third Party ABCP
was formed. Purdy Crawford, a well known securities lawyer from Osler Hoskin
Harcourt, was hired as Chairman of this Committee. The members of the Montreal
Accord Group and Pan Canadian Committee are shown in Figure 4.
Figure 4: Pan Canadian Committee for Investors in
Third Party ABCP & Montreal Accord Signatories
Pan Canadian Committee for Investors in Third Party ABCP
6-Sep-07
ATB Financial
Caisse De Dépôt MA
Canaccord Capital
Canada Mortgage and Housing Corp
Canada Post
Credit Union Central of Alberta
Credit Union Central of Canada
Desjardins Group
Magna International MA
National Bank MA
Northwater Capital Management
NAV Canada
PSP Investments MA
MA - Original signatories of Montreal Accord
Montreal Accord Signatories
16-Aug-07
ABN Ambro
Barclay Capital
Caisse De Dépôt PCC
Desjardins Group PCC
Deutsche Bank
HSBC Securities
Merrill Lynch
National Bank PCC
PSP Investments PCC
UBS
PCC - Also on the Pan Canadian Committee for Investors in Third Party ABCP
11
What one notices about the Montreal Accord Group in Figure 4 is who is not on it. The
big five Canadian banks outside of Quebec are absent, while there are 6 international
banks/investment banks on it. Quebec's National Bank and Desjardins Group are in the
Montreal Accord Group. The counterparties to the credit default swaps and the
signatories of the liquidity agreements in the Third Party ABCP are not publicly
disclosed in the Information Memorandum for the problem conduits. Deutsche Bank and
Barclays Bank for sure, and probably the other 4 international banks, are signatories to
liquidity agreements backing the Third Party ABCP. Three of the ABCP conduits
disclosed that Deutsche Bank and Barclays Bank walked from their liquidity agreements
due to their opt out provisions. The other liquidity agreement signatories have either
already walked or are expected to walk too.
Deutsche Bank and HSBC Securities are also amongst the original distribution agents
listed in the Information Memorandum for the problem conduits as shown in Figure 2.
BMO, CIBC Markets, RBC Dominion, Scotia Capital, Laurentian Bank and Société
Générale Securities are distribution agents too, but they have not volunteered to be on the
Montreal Accord Group.
Half of the 12 member Pan Canadian Committee is government pension funds or crown
corporations. The Caisse De Dépôt and PSP Investments have not publicly disclosed the
amount invested in Third Party ABCP. On the other hand, ATB Financial, an Alberta
Government crown corporation, announced it holds $1.2 billion of Third Party ABCP.
The Ontario Government has publicly disclosed its exposure to Third Party ABCP at
$863 million, of which $700 million is at the Ontario Financing Authority, $103 million
at the Ontario Power Generation Corporation and $60 million at the Ontario Teachers
Pension Plan. Interestingly, there is no Ontario Government representative on the Pan
Canadian Committee membership list in the September 6, 2007 media release. The
Ontario Government election is on October 10, 2007 and perhaps there is concern about
Ontario's exposure becoming a high profile election issue.
Magna International joined the Pan Canadian Committee, as the sole corporate
representative amongst at least 29 public corporations, that have publicly disclosing their
ownership of the Third Party ABCP as noted in Figure 3.
Ernst & Young Inc. announced that holders of over 81 % of the outstanding Third Party
ABCP release have signed agreements or acknowledgements indicating their support for
the interim arrangements provided in the Montreal Accord.
Not a Controllable Situation Since Credit Default Swaps Not Covered By the
Companies' Creditor Arrangement Act
The Globe and Mail article written by Sandra Rubin, "Class-action guys see profit in
subprime mess," on September 5, 2007 says:
12
"Credit default swaps have become so pervasive in Canada that they're linked to about $25-billion of the
$40-billion of the outstanding third party asset-backed commercial paper, says a senior lawyer familiar with
events…. Here's the thing: Under Canadian restructuring law [Companies' Creditor Arrangement Act], you
can't stay a counterparty to a swap. By law, the parties who bought the protection can't be prevented from
exercising their rights…..If the swaps are in default, expect the climate to turn on a dime."
Canadian owners of the Third Party ABCP, and their millions of affected
Canadians, need to know the specific list of credit default swap counterparties and
signatories of the liquidity agreements. It appears that in virtually all cases, the banks are
on both sides of the equation, as a counterparty to credit default swaps and a signatory for
the liquidity agreement for the same conduit. There needs to be concern that the
banks put themselves into the powerful position of being able to make a call for cash to
pay for default damages under their swap, knowing that they would walk from their
liquidity agreement and gain access to the conduit's collateral of top rated assets held in
trust. These bank counterparties would then control the triggering of the crisis for the
Third Party ABCP owners in Canada, if there was widening of credit spreads due to
deteriorating credit conditions. At the same time, these banks would know that their own
interests were protected in their self made crisis by their first call on the top quality
collateral within the conduit.
Even in situations where a bank is not both a counterparty for a credit default swap and a
signatory of the liquidity agreement in the same conduit, one should question whether
two different banks knew about the other's role in the conduit and had access to each
other's detailed contract terms. Then, the two acting together have the same consequence
of one bank involved as counterparty of the credit default swap and liquidity agreement.
The international banks, without significant Canadian retail operations and Mainstreet
presence in Canada, would be the most inclined to participate in the scheme of being both
counterparty to a credit default swap and signatory to a defective liquidity agreement,
which is to the detriment of Canadian accredited buyers. These international banks
would not have the same reputation and business motive for voluntary offers to make
retail customers in Canada whole. The international banks could also benefit from the
weak Canadian regulatory regime governing defective investment products, its failure to
regulate international banks, and its undue onus on accredited investors to conduct due
diligence.
One further nuance about the rights of the counterparties to the credit default swaps held
in the Third Party ABCP conduits is their right to call for additional margin. The original
August 16, 2007 Montreal Accord media release attached gave subtle reference to the
problem that the Canadian Third Party ABCP conduits had received margin calls and
would receive further margin calls. The original media release does not, however, refer
specifically to margin calls arising from credit default swaps held in the conduits. It is
the margin call(s) that probably triggered the freeze-up of the Third Party ABCP market
in Canada. Once the word spread about credit default swap margin calls, there would be
no new buyers for the Third Party ABCP current owners who wanted to sell or get their
cash back on maturity.
13
A margin call to the conduits means that they need to add more cash/quality assets to the
collateral backing their liability to cover future default damages as prescribed in the
credit default swap. Then, if the additional margin is not put into the conduit, the
counterparty would have the immediate right to call the swap into default and take steps
to demand cash payment funded from their collateral. So, if there is $50 owing to the
counterparties at today's credit default swap price for every $100 of Third Party ABCP,
then it becomes payable today unless the conduit adds cash/quality assets to the collateral
balance. So, without new cash/quality assets added, the conduit does not have the luxury
of time for the credit default swap price to recover, when credit spreads narrow after
the world-wide credit crunch is over.
Office of Superintendent of Financial Institutions Permitted Defective
Liquidity Agreements
Julie Dickson, Superintendent of the Federal Office of the Superintendent of Financial
Institutions Canada (OSFI) spoke to the National Insurance Conference of Canada in
Montreal, Quebec on Monday, October 01, 2007. She responds to criticisms about the
OSFI B-5 regulation below, which clearly shows that OSFI permitted the banks to sign
what I call "the Made-in-Canada defective liquidity agreements" for the Third Party
ABCP.
OSFI B-5 Regulation says:
"Liquidity support is a commitment to lend to, or purchase assets of, an SPE in order to provide investors
with assurance of timely payment of principal and interest. Liquidity support may include a general market
disruption clause. A general market disruption can be defined as a disruption in the Canadian commercial
paper market resulting in the inability of Canadian commercial paper issuers, including the SPE, to issue
any commercial paper, and where the inability does not result from a diminution in the creditworthiness of
the SPE or any originator or from a deterioration in the performance of the assets of the SPE."
Julie Dickson has these excuses in her attached October 1, 2007 speech:
(1) Its not my job.
In assessing the comments that have been made, I have to note that it is not OSFI's role to use our powers
over banks (which are designed to help protect bank solvency) to regulate capital markets. As a prudential
regulator we do not tell Canadian investors what to invest in or not invest in. We do not tell unregulated
players how to go about their business. We do not tell banks to provide liquidity to certain players and on
what conditions.
In summary, OSFI focuses on the strength of the financial institutions because that is our job – safety and
soundness of institutions that make promises to pay depositors and policyholders. OSFI focuses on capital,
or buffers for the unexpected, as well as stress testing, liquidity and continual enhancement of monitoring
systems and risk management, as that plays a key role in maintaining a safe and sound financial system.
(2) Sophisticated investors should have known, and the S & P and DBRS had different
credit rating opinions.
14
4. Uniqueness of the Canadian ABCP market – The fact that Canadian investors were buying ABCP with
one rating and with limited liquidity lines was also known. S&P had put out reports explaining why they
would not rate a product that had liquidity lines that could only be drawn in the event of a general market
disruption (GMD or so-called Canadian style due to their popularity in Canada). S&P suggested that
liquidity lines that were more readily available in time of need (so-called global style lines) were better for
the investor. Others such as DBRS believed that GMD lines were sufficient given the higher level of credit
enhancement in Canadian structures compared to international structures. Sophisticated investors and
advisors supported the DBRS view.
(3) Our banks have fixed the problem now, by moving to the international standard for
liquidity agreements.
OSFI applied internationally agreed capital rules. The more risk of a liquidity line being drawn, the more
capital a bank had to hold (the charge was 10% for global style lines). Where the risk of a line being drawn
was extremely remote, the capital charge was zero. These are international capital rules. Despite headlines
suggesting lax rules, loose rules, or different rules, Canadian rules are robust and aligned with international
standards. Like all international banks, Canadian banks have stepped in to support their conduits, and this
has helped to bring back investor confidence. The banks have also announced a move to global style lines,
again to reassure investors.
So, now Canadians discover there is another regulatory agency that protects the major
Canadian banks, at the expense of no investor protection for investors. Even the OSFI
role to supervise and ensure the solvency of federally registered pension funds has taken
a back seat to serving the Canadian banks by allowing them to sign liquidity agreements
that they knew would have virtually no benefit to the ABCP pension fund owners. The
Federal Office of Superintendent of Financial Institutions has effectively assisted the
banks to skim fees from the ABCP conduits, which reduced the interest paid to the retail
investors, Canadian pension funds and corporations owning ABCP.
On the excuse that OFSI does not regulate the international banks who signed most of the
ineffective liquidity agreements in the 23 Third Party ABCP that are frozen, is Canada
open to all international banks who seek to make profits by skimming and misleading
Canadian retail investors and pension funds? Also, OSFI cannot promote the Canadian
banks to be "saintly" on the defective ABCP liquidity agreement issue. The Canadian
banks have indeed made voluntary offers to make retail investor whole on their own
Bank ABCP, but their investment bank subsidiaries are well represented amongst the
originating distribution agents for the problem Third Party ABCP sold to accredited
pension funds and corporations.
Standard & Poors Canada wrote a research report in 2002 called, "Leap of Faith:
Canadian Asset-Backed Commercial Paper Often Lacks Liquidity Backup." This 2002 S
& P report was prescient in predicting that the OSFI B-5 regulation would not protect the
Canadian banks as it was intended to do. Rather, the extremely limited use
liquidity agreement wording of B-5 would contribute to a market confidence contagion
within ABCP, if there became a need for the conduits to make liquidity calls. This is
what has just happened!
15
S & P 202 Report, "Leap of Faith," says:
"The Canadian market is unique in its acceptance of ABCP conduits with extremely limited-use liquidity
support. Why has this situation evolved? The arrangement was initially implemented in 1994 as the
sponsoring banks interpreted then-issued regulation B-5 of the Office of the Superintendent of Financial
Institutions (OSFI). Since then, the practice has become institutionalized among market participants.
OSFI's concern is with ensuring banking system stability, and the capital adequacy of individual banks. To
the extent a bank takes credit risk through the provision of a lending facility, OSFI requires the bank to
hold capital against that exposure. In B-5, OSFI makes an exception for liquidity lines to ABCP specialpurpose
entities. OSFI allows zero-capital treatment for a liquidity line if it is cancelable or reducible and
only available in circumstances of widespread market disruption."
"Interestingly, the overall effect of B-5 may be to exacerbate, not limit, bank-system exposure to credit
problems. Were a conduit able to rely on timely liquidity as funding support, this could preempt a conduitspecific
default, and avoid market confidence contagion to other conduits managed by the same sponsors,
or to conduits in general.
Nevertheless, given conventional Canadian liquidity support limitations, the liquidity might not be
available, and a conduit facing operational difficulties or incremental performance deterioration could face
a ratings downgrade. This, in turn, could lead to an outright default because the unavailability of liquidity
facilities coincidental with faltering market confidence would cause the conduit to be unable to roll over
maturing ABCP."
The Pan Canadian Committee Cannot Make the Pension Beneficiaries,
Taxpayers and Shareowners Whole
"Our Investor Committee will be looking to implement a solution that addresses the best
interests of investors generally, and at the same time allows for a successful restructuring
and a return to market stability for these investments", said Mr. Crawford who added that
"in considering the best interests of investors, I will be guided by my own views as to
fairness." (CNW Release, A Pan Canadian Committee Chaired by Mr. Purdy Crawford
will oversee Third Party Commercial Paper restructuring process, September 6, 2007.)
The Montreal Accord Group comprises the senior executives of banks/investment banks
who either signed defective liquidity agreements, or distributed defective investment
product. The Pan Canadian Committee comprises senior executives of investor
organizations, that were either personally negligent or duped into buying the defective
commercial paper.
Both the Montreal Accord Group and Pan Canadian Committee members are motivated
to cover-up their responsibility for the Third Party ABCP damages from the pension
beneficiaries, taxpayers and shareowners who will be paying for the damages. The
banks/investment banks want a quick solution to mitigate litigation risk and liability for
any damages associated with known defective features in the ABCP or any
misrepresentations on the characteristics of the product in the Information Memorandum.
The professional money managers want to protect their personal reputation and jobs and
16
they are not personally liable for the damages that will be borne by the pension
beneficiaries, taxpayers and shareowners.
There is a reasonable question about why the banks/investment banks who were either
negligent or intended to sell defective products unique to Canada, should be permitted to
be in the inner circle of investment banks putting together a restructuring offer where it is
likely that the owners will not be made whole. The pension beneficiaries, taxpayers
and shareowners need to be assured that the restructuring offer being presented is
the best offer available from all parties who may have an interest in the assets from
throughout the world. This can only be achieved by the creation of a long term
note, that has complete transparency on its underlying assets and that meets
international standards acceptable for resale in the international markets.
An inner circle of investment banks, especially those who may have been negligent
or deceitful, should not be permitted to make a discount offer to the owners needing
cash, with the intent to flip the restructured securities into the international fixed
income market at considerable profits for themselves. Such ill-gotten profit belongs
to the pension beneficiaries, taxpayers and shareowners, who would get this money
in a properly conducted public auction at the outset.
Urgent Changes Needed in the Workout Process
The Bank of Canada Governor David Dodge and Federal Finance Minister Jim Flaherty
have made statements supporting the Montreal Accord Group and the Pan Canadian
Committee, crediting the process as an orderly restructuring of the Canadian ABCP
market, that provides an opportunity for the affected parties to work through the many
complex issues related to the market.
But the process is seriously flawed because the Montreal Accord Group and Pan
Canadian Committee Members are made up of the people who need to "cover their asses"
and who are not paying for the loss - the pension beneficiaries, taxpayers and
shareowners are.
The Federal Parliament, through the Federal Minister of Finance, should appoint a
qualified independent monitor to ensure that the interests of the pension
beneficiaries, taxpayers and shareowners are being met in the decisions of the
Montreal Accord Group and Pan Canadian Committee. The pension beneficiaries
and shareowners should not be expected to enter subsequent civil litigation against
the managers hired to conduct duties on their behalf, in the event these managers
accepted a quick concessionary solution to cover up for their own negligence in
purchasing defective Third Party ABCP.
17
The purpose of the requested independent expert monitor appointed by the Federal
Government is to ensure that the damages to pension beneficiaries, taxpayers and
shareowners are mitigated.
(1) That there will be no quick opaque discount offer made by the vendor group ( = the
conduit sponsors and all contract parties) and accepted by the investment management
executives who bought the defective Third Party ABCP, in order to cover-up negligence
or deceit and to protect the reputations of the vendor group (including all contract
parties) and of the investment management executives.
(2) There needs to be a government monitor acting in the public interest in terms of
identifying any securities, competition or criminal law misconduct within the vendor
group and DBRS, whose knowledge and threat of enforcement would leverage a better
restructuring solution from the vendor group than otherwise. If there is sufficient
evidence of negligence or misrepresentation on the part of the vendor group, then
the pension beneficiaries, taxpayers and shareowners should be made whole.
(3) The public interest monitor must ensure that the Canadian Third Party ABCP owners,
and their millions of affected Canadians, know the names of the banks who are the
counterparties to the credit default swaps and the signatories of the liquidity agreements.
Bank counterparties in credit default swaps that have the right to call for cash payments,
should not be permitted to be an exclusive group entitled to make restructuring offers to
the Canadian Third Party ABCP owners, especially since when they were also signatories
for the Made-in-Canada defective liquidity agreements in the same conduits.
(3) Worse still, the inside vendor group cannot be allowed to make discount deals, only
to flip the notes acquired into the international fixed income markets for windfall gains to
themselves that belong to the pension beneficiaries, taxpayers and shareowners of
Canada. There needs to be a public auction for the purchase of the restructured
notes, where international fixed income asset buyers and investment banks are
permitted entry into the data room now and the opportunity to make fully informed
bids for each of the conduits.
(4) The independent government monitor must ensure that investment banking fees,
legal fees, accounting fees, stalking horse bid fees and any other fees not named are held
to reasonable amounts. Too much money is being spent on professional fees to mop
up problems caused by defects in investment products that were designed and
distributed by the same professionals. Employment for investment bankers, lawyers
and accountants manufacturing and repairing defective investment products is not
a good industry for Canada.
(5) Procedures must be adopted to ensure full transparency to the independent
government monitor or other agents for the pension beneficiaries, taxpayers and
shareowners. Bona fide agents for the pension beneficiaries, taxpayers and
18
shareowners need to be added to the Ernst & Young protocol for access to the data
room. The specific information requiring transparency is:
(a) the assets owned by the conduits that issued the Third Party ABCP;
(b) all material contracts, including liquidity agreements
(c) the features of the restructured long term notes;
( d) all investment banking, legal and accounting fees;
(e) the process for a public auction of the long term notes by the owners seeking
immediate cash.
A Final Word on Where Are the Securities Regulators?
Third Party ABCP is another Made-in-Canada defective investment product, which
demonstrates there is no investor protection for investors and pensioners in Canada.
Canadians are learning about Third Party ABCP losses in the wholesale market, just as
income trusts are stumbling into their own financial crisis of $11 billion losses to date
within the retail market. 26% of all income trusts have suspended or substantially cut
distributions due to this business model's flawed design and its reliance on deceptive
financial reporting.
The provincial securities commissions have adopted the principle that accredited
investors do not need investor protection since they are sophisticated and have
formidable power and resources to seek redress for negligence or malfeasance by
issuers or investment banks. But, the damages to pension beneficiaries, taxpayers
and shareowners from Third Party ABCP will be up to $20 billion. Such
unnecessary losses are bad for the country's economy and its already broken
reputation on securities regulation. Canada needs to adopt a national securities
regulator, with proper civilian oversight and effective enforcement.
The Ontario Securities Commission has taken advice from the issuers, investment bank
distributors and securities lawyers who design new investment products, rather than from
their own experts or retained independent experts. The OSC has a Commodity Futures
Advisory Board that consults with and advises OSC staff on: developments in the nature
of contracts and manner of trading; and, the influence of trading in contracts on the
economy of Ontario. All four OSC Commodity Futures Advisory Board participants are
directly involved in the vendor group for the defective Third Party ABCP.
David Ellins Coventree Capital Group Inc.
Carol Pennycook (Chair) Davies Ward Phillips & Vineberg
Stephen Elgee BMO Nesbitt Burns
Jim Sinclair Northwater Capital Management Inc.
Davies Ward Phillips & Vineberg is one of three legal firms that signed off on the 23
problem ABCP conduits listed in Figure 2. David Brown, the former Chairman of the
OSC and the Current Chairman of the RCMP Task Force on Governance and Cultural
Change, is a current Counsel with the firm Davies Ward Phillips & Vineberg.
19
Both David Brown, the former OSC Chairman, and David Wilson, the current OSC
Chairman, failed to detect since 2001 that DBRS was giving top investment grade ratings
to Third Party ABCP that did not meet the international standard for sound liquidity
agreements. Coventree Capital, Nereus Financial, Northwater Capital Management and
Dundee Securities are Ontario registrants. The OSC was not able to prevent the loss to
the Ontario Government that has publicly disclosed it exposure to Third Party ABCP at
$863 million amongst three entities.
Similarly, Jean St.-Gelais, Chairman of Quebec's l'Autorité des marchés financiers,
appears to have been oblivious to the significant participation of Quebec registrants in
defective Third Party ABCP: Caisse de dépôt et placement du Québec, National Bank,
Desjardins Bank Securities, Laurentian Bank Securities and Société Générale Securities.
Finance Minister James Flaherty is right to say that Canada should have a national
securities commission, so that it can be a better first responder to financial crises,
especially ones that are made in Canada and involve a market abuse. Indeed, there
are credit crunch problems throughout the world, where there is strong securities
regulation such as in the U.S. and the U.K. But, in those countries, government experts
and expertise funding are on standby to answer 911 calls from the owners of distressed
securities, who need well orchestrated and fair solutions. For sure, the private sector
players involved in negligence or deception cannot seize the agenda to act in their own
interests rather than the interests of the actual people suffering the damages, the pension
beneficiaries, taxpayers and shareowners.
The House of Commons Finance Committee must hold hearings on the lessons
learned from the Third Party ABCP fiasco and the general malfunctioning of
Canada's securities regulation and white collar crime enforcement system. The
hoped for outcome of this hearing would be a new Federal Government securities law
and a national securities commission. The existing investment industry SRO's and
provincial securities commissions have failed to protect Canadians once again. Average
Canadians can no longer afford to take more billions of dollar damages from Made-In-
Canada defective investment products and white collar securities crime.
Canada's top priority, however, is to develop a properly functioning independent RCMP
white collar crime police unit, that has the confidence of international police forces and
collaborates with municipal and provincial police forces throughout Canada. The RCMP
must discontinue its reliance on referrals for criminal investigations from the investment
industry SRO's and the provincial securities commissions.
Diane Urquhart
Independent Analyst
Mississauga, Ontario
Telephone: (905) 822-7618
Cell: (416) 505-4832

[admin]

Mortgage fraud on a massive scale

Diane Francis
Financial Post


Thursday, October 04, 2007


Bad guys never rest. And the latest, greatest example of fraud on a massive scale involves the subprime mortgage, or ABCP (asset-backed commercial-paper) mess.

A combination of fraudsters, the Mafia and a lot of financial intermediaries on Wall Street have pulled off something bigger than Enron, the savings-and-loan mess and Lenny Rosenberg's 1983 apartment flip all combined.

At its root is a U.S. investment-banking and mortgage-brokerage system that's broken, had little government oversight and was rife with crooks. Last, but not least, most will get away with this because the globalization of capital markets allowed them to export the crime to Canada, Britain, Europe and elsewhere.

Here's what we have now: U.S. homeowners with mortgages they should never have obtained who cannot make the payments because interest rates have gone up and who cannot sell because house values have gone down.

Some foreclosures are happening but it's a presidential election year and even George W. Bush, the U.S. President, has talked about back-stopping homeowners so they don't lose their residences. Besides that, those holding mortgages cannot foreclose entire neighbourhoods, mostly modest ones, without destroying values for years.

When the savings-and-loan debacle swept the United States in another real estate recession, the properties underlying non-performing or sub-standard loans on properties were seized by Washington and sold off slowly over years. To do otherwise would flood the real estate market with properties and cause real estate depression in certain regions.

On the other end are the "rich" victims. These are the investors who bought bundles of these mortgages on what's euphemistically referred to as an "opaque" market. They bought junk along with OK stuff, but it was all neatly passed along and packaged as more creditworthy than it really was.

In August, the world realized what happened and debt markets crashed at once, forcing central banks and big banks to band together and halt a panic. Here's some information about the fraud techniques: - Mortgage broker licences were handed out indiscriminately and many of these companies sprung up, hiring people, often uneducated immigrants or crooks, and splitting handsome fees with them. - Initial lenders granted mortgages higher than the properties' values to people who wouldn't qualify for a mortgage in Canada or Europe. - Bogus valuations were involved, as happened in the Rosenberg fraud in Toronto, where $325-million worth of apartment buildings were "valued" and mortgaged for $500-million by trust companies in on the scam. - Mortgages were "sold" at discounts to a series of packagers, mostly on Wall Street, who took small fees and passed along the loans in bundles with good loans all over the world. - The rich institutions and funds that ended up with this junk were somewhat greedy or naive or both. How safe could they have been, given the high interest rates they were yielding?

Finger-pointing is rampant south of the border. U.S. Senate banking chairman Chris Dodd of Connecticut said subprime lenders were "predatory" and the government was negligent. But at the end of the day, this is a very simple, but huge, fraud due to the lack of proper U.S. mortgage brokerage licensing.

dfrancis@nationalpost.com

© National Post 2007

(advocate comments........Diane's article gives a good understanding of the basic, underlying flaw in many tainted investment products discussed in these forums.........the flaw that crooks acting as middlemen can and will package up any kind of quasi investment, and by "putting lipstick on the pig" sell it off to the public without care for the result.
Under section 380 of the Canadian Criminal code many of these actions meet the definition of "Fraud", and should be held accountable. The industry itself cannot and will not take this step, so it is now up to legislatures to remove from them the power to self regulate.)

[admin]

----- Original Message -----
From: Urquhart
To: 'Joe Killoran'
Sent: Saturday, September 29, 2007 4:26 PM

Subject: September 28th Media on Canada's Third Party ABCP Crisis
& My Independent Research Report

[ ABCP -- asset backed commercial paper ]
Here's my independent research report on the defective 'Made-in-Canada' Third Party ABCP.

Also, for your convenience, here is this morning's media coverage on the evolving Canadian Third Party ABCP crisis.

My independent research report concludes there is a need for an expert independent monitor appointed by the Federal Government to oversee the information and decisions of the Montreal Accord Group and Pan Canadian Committee. These two entities are making decisions on the restructuring of the frozen Third Party ABCP into long term floating rate notes; and, the restructuring offer to be made to the owners of the new notes, who seek cash rather than owning the new notes over the long term. I understand that the President of the Canadian Labour Congress, Ken Georgetti, has written a letter to Federal Finance Minister James Flaherty, cc'd to the Bank of Canada Governor David Dodge, that is asking the Minister to appoint an expert independent monitor to protect the interests of the 80% of its own members, who are pension fund beneficiaries.

The purpose of the independent expert monitor appointed by the government is to ensure that the damages to pension beneficiaries, taxpayers and shareowners are mitigated.

(1) That there will be no quick opaque discount offer made by the vendor group and accepted by the executives who bought the bad paper, in order to cover-up negligence or deceit and to protect the reputations of the vendor group and the executives of the many government pension funds, crown corporations and corporations owning the paper. The current decision-makers in the room are either the vendor group, who benefited from the sale of defective investment paper; or professional buyers, who bought the defective investment paper after inadequate due diligence and misplaced trust in the vendor group and DBRS.

(2) There needs to be a government monitor acting in the public interest in terms of identifying any misconduct within the vendor group, including contract parties, and DBRS, whose knowledge and threat of enforcement would leverage a better restructuring solution from the vendor group than otherwise. International bank counterparties in credit default swaps cannot hold Canadian owners hostage with their right to call for cash payments, while at the same time they are amongst the inside group permitted to make distress offers to the executives of owners.

(3) Worse still, the inside vendor group, including contract parties, cannot be allowed to make discount deals, only to flip the notes acquired into the international fixed income markets for windfall gains to themselves that belong to the pension beneficiaries, taxpayers and shareowners of Canada. There needs to be a public auction for the purchase of the restructured notes, where international fixed income asset buyers and investment banks are permitted entry into the data room now and the opportunity to make fully informed bids for each of the conduits.

(4) The independent government monitor must ensure that investment banking fees, legal fees, accounting fees, stalking horse bid fees and any other fees not named are held to reasonable amounts. Too much money is being spent on professional fees to mop up problems caused by defects in investment products that were designed and distributed by the same professionals.

Diane Urquhart
Independent Analyst

[admin]

good article, supports the premise that trusting, vulnerable, and at times foolish members of the public can (and will be) be easily preyed upon by financial professionals as well as those who serve them.


NEW YORK TIMES
--------------------------------------------------------------------------------

September 30, 2007
Economic View
Six Fingers of Blame in the Mortgage Mess

David G. Klein
By ALAN S. BLINDER
SOMETHING went badly wrong in the subprime mortgage market. In fact, several things did. And now quite a few homeowners, investors and financial institutions are feeling the pain. So far, harried policy makers have understandably focused on crisis management, on getting out of this mess. But soon the nation will turn to recrimination — to good old-fashioned finger-pointing.

Finger-pointing is often decried both as mean-spirited and as a distraction from the more important task of finding remedies. I beg to differ. Until we diagnose what went wrong with subprime, we cannot even begin to devise policy changes that might protect us from a repeat performance. So here goes. Because so much went wrong, the fingers on one hand will not be enough.

The first finger points at households who borrowed recklessly to buy homes, often saddling themselves with mortgages that were all too likely to default. They should have known better. But what can we do to guard against it happening again?

Not much, I’m afraid. Gullible consumers have been around since Adam consumed that apple. Greater financial literacy might help, but I’m dubious about our ability to deliver it effectively. The Federal Reserve is working on clearer mortgage disclosures to help borrowers understand what they are getting themselves into.

“Warning! This mortgage can be dangerous to your family’s financial health.”
While I applaud the effort, I’m skeptical that it will work. If you have ever closed on a home, you know that the disclosure forms you receive are copious and dense. Should we add even more?
Fewer words, and in plainer English, might help, especially if they highlighted the truly important risks.

“In two years, your mortgage payments could double.”
But the truth is that there is much to disclose, that complicated mortgage products are, well, complicated, and that people don’t read those documents anyway.
It seems more promising to point a finger directly at lenders. Some lenders sold mortgage products that were plainly inappropriate for customers, and that they did not understand. There were numerous cases of unsophisticated borrowers being led into risky mortgages.

Here, something can be done. For openers, we need to think about devising a “suitability standard” for everyone who sells mortgage products. Under current law, a stockbroker who persuades Granny to use her last $5,000 to buy a speculative stock on margin is in legal peril because the investment is “unsuitable” for her (though perfectly suitable for Warren Buffett). Knowing that, the broker usually doesn’t do it.

But who will create and enforce such a standard for mortgages? Roughly half of recent subprime mortgages originated in mortgage companies that were not part of any bank, and thus stood outside the federal regulatory system. That was trouble waiting for a time and a place to happen. We should place all mortgage lenders under federal regulation.

That said, bank regulators deserve the next finger of blame for not doing a better job of protecting consumers and ensuring that banks followed sound lending practices. Fortunately, the regulators know they underperformed, and repair work is already under way.

Regulators also need to start thinking about how to deal with a serious incentive problem. In old-fashioned finance, a bank that originated a mortgage also held it for years (think of Jimmy Stewart in “It’s a Wonderful Life”), giving it a clear incentive to lend carefully. But in newfangled finance, banks and mortgage brokers originate loans and sell them quickly to a big financial firm that “securitizes” them; in other words, it pools thousands of mortgages and issues marketable securities representing shares in the pool. These “mortgage-backed securities” are then sold to investors worldwide, to people with no idea who the original borrowers are.

Securitization is a marvelous thing. It has lubricated the market and made mortgages more affordable. We certainly don’t want to end it. But securitization sharply reduces the originator’s incentive to scrutinize the creditworthiness of borrowers. After all, if the loan goes sour, someone else will be holding the bag. We need to find ways to restore that incentive, perhaps by requiring loan originators to retain a share of each mortgage.

But wait. Don’t the ultimate investors have every incentive to scrutinize the credits? If they buy riskier mortgage-backed securities in search of higher yields, isn’t that their business? The answer is yes — which leads me to point a fourth finger of blame. By now, it is abundantly clear that many investors, swept up in the euphoria of the moment, failed to pay close attention to what they were buying.

Why did they behave so foolishly? Part of the answer is that the securities, especially the now-notorious C.D.O.’s, for collateralized debt obligations, were probably too complex for anyone’s good — which points a fifth finger, this one at the investment bankers who dreamed them up and marketed them aggressively.

Another part of the answer merits a sixth finger of blame. Investors placed too much faith in the rating agencies — which, to put it mildly, failed to get it right. It is tempting to take the rating agencies out for a public whipping. But it is more constructive to ask how the rating system might be improved. That’s a tough question because of another serious incentive problem.

Under the current system, the rating agencies are hired and paid by the issuers of the very securities they rate — which creates an obvious potential conflict of interest. If I proposed that students pay me directly for grading their work, my dean would be outraged. Yet that’s exactly how securities are rated. This needs to change, but precisely how is not clear.

SO that’s my list of men (and a few women) behaving badly. But as we point all these fingers, let’s remember the sage advice of the late and dearly missed Ned Gramlich, the former Fed governor who saw the emerging subprime problems sooner and clearer than anyone. Yes, the subprime market failed us. But before it blew up, it placed a few million families of modest means in homes they otherwise could not have financed. That accomplishment is worth something — in fact, quite a lot.

We don’t have to destroy the subprime market in order to save it.

Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.

[admin]

Tuesday » September
18 » 2007
Canada suffers $10B 'discount'
Tuesday, September 18, 2007
OTTAWA - The lack of a single securities regulator in Canada costs the economy as
much as $10 billion and 65,000 jobs a year, according to a U.S. securities law
expert commissioned to advise the federal government.
John Coffee, a professor at Columbia University law school in New York, said Monday
he based his figures on various existing studies.
"There is a discount on Canadian securities," he said. "You have to sell more of your
stock to raise the same money in comparison, say, to a similar U.S. company. And
you may have to pay more on your debt rate, too."
The so-called Canadian "discount" stems from the fact investors are less confident
about putting money into Canadian public companies, he said.
The reason for this is they feel the Canadian system, which has 13 provincial and
territorial agencies that monitor the industry, leads to less reliable enforcement of
public companies and can lead to poorer corporate governance.
Less checks on activities such as insider trading, Coffee noted, result in a lower level
of return for ordinary investors.
© The Edmonton Journal 2007
CanWest News Service
Copyright © 2007 CanWest Interactive, a division of CanWest MediaWorks Publications, Inc.. All rights reserved.
Print Story - canada.com network Page 1 of 1
http://www.canada.com/components/print. ... e0e0355053 9/18/2007

[admin]

Tuesday » September
18 » 2007
Caisse top ABCP holder
More than $20B; Half of Canadian total ravaged by
crisis, sources say
Tuesday, September 18, 2007
The Caisse de depot et placement du
Quebec has the greatest exposure to the
asset-backed securities market at more
than $20-billion, according to Ontario
government sources, which is more than
half of the estimated $35-billion of nonbank-
backed, asset-backed commercial
paper (ABCP) held in Canada and ravaged
by a global liquidity crisis.
The Caisse spearheaded "the Montreal
proposal" on Aug. 16 to help institutions
buy time to restructure their finances to
deal with the credit crunch emanating from
the U.S. subprimemortgage crisis.
A spokeswoman for the Caisse declined to
talk about the fund's ABCP holdings. "We
have seen quite a few numbers published
and we don't comment on any of them," said Lucie Freniere.
A number of companies have disclosed their exposure including Ontario Power
Generation Inc., which reported holdings of $102.6-million; Canada Post, which holds
$27-million in its fully funded pension plan; Nav Canada, which said last week it holds
about $368-million worth, and the Greater Toronto Airports Authority with ABCP
investments of about $249-million. The Ontario government, through the Ontario
Financing Authority, holds more than $700-million.
To calm market turmoil, the signatories of the accord agreed not to ask for money
from lenders or take money out of the trusts for 60 days.
On Sunday, Jim Flaherty, the Minister of Finance, said the government is monitoring
the credit issues that have spread from the U.S. subprime-mortgage crisis, but told
reporters that "we hope they are able to sort it out among themselves." He did not
give any time-line for a resolution. He also praised the creation of the Mont-real
accord, which he said was the "envy" of other international organizations.
Canada's market for non-bank-sponsored ABCP seized up on Aug. 13 after being hit
by repercussions from the U.S. crisis. But due to a glitch in industry practices in this
country, banks did not step up with emergency funding when the market dried up,
leaving investors on the hook for any losses.
Since the beginning of August, holders have been unable to sell their notes. Under
the Montreal proposal, the $35-billion market would be converted to longer-term debt
with maturities based on the underlying assets.
Many investors, especially smaller companies, say they are frustrated with the
situation. They say they thought they had bought short-term investments that were
as liquid as cash only to find out that it may take a lot longer to get their money out.
Indeed, some analysts predict there will be significant losses.
Karen Mazurkewich And John Greenwood
Financial Post
CREDIT: Christinne Muschi/ National Post
Henri-Paul Rousseau, Chairman of the
Board and CEO for the Caisse de Depot et
placement du Quebec
Print Story - canada.com network Page 1 of 2
http://www.canada.com/components/print. ... f7&k=91390 9/18/2007
"I have lots of concerns about how this thing is being put together," said a senior
official at one company with significant ABCP holdings.
Meanwhile, the broader short-term debt market has also been hit with subprime
contagion as investors backed away in recent weeks, sparking concerns about more
liquidity problems.
Issuers responded in the past few weeks by jacking up yields by more than 50 basis
points in some cases, but industry players warn that such yields are not sustainable.
They say issuers will move to other more economic financing options such as term
loans.
Market activity "has improved" in the past few days, said one fixed-income trader,
who attributed the change to the fatter yields.
"We're starting to see a material change, but we're not out of the box yet."
Others are less optimistic. They say the crucial problem is that as things are, it no
longer makes sense for companies to finance using commercial paper.
Unless spreads come down in a matter of the next few weeks, the major banks could
be forced to take billions of dollars of existing debt onto their books, analysts said.
© National Post 2007
Copyright © 2007 CanWest Interactive, a division of CanWest MediaWorks Publications, Inc.. All rights reserved.
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Saturday » September
15 » 2007
Unitholders on hook for Global paper
Deutsche Bank Declines To Repay Maturing Notes
Wednesday, August 15, 2007
Global Diversified Investment Grade Income Trust and Global Diversified Investment
Grade Income Trust II have something in common: Both have been unable to fund
maturing issues of asset-backed commercial paper. And both, through their specialpurpose
funding vehicles -- MMAI-I Trust and Silverstone Trust -- also thought they
had an arrangement with Deutsche Bank.
Yesterday, the two issuers -- both promoted by National Bank -- said that after
requesting Deutsche Bank provide liquidity by repaying the maturing notes, the
German bank declined. In both cases, unitholders are on the hook.
Both issuers deal in the exotics. The two provide an economic interest in a mezzanine
tranche of credit-default swaps on a portfolio of mortgage-backed securities, assetbacked
securities, structured-finance securities and synthetic corporate exposure.
Global Digit raised $107.1-million in September, 2004, at $10 per unit; Global Digit II
raised $149.5-million, also at $10 per unit. Yesterday, Global Digit (DGU) closed at
$4.50, down $2.50; while Global Digit II (GII-U) at $1.60, down $1.70.
Investors in Global Credit Pref Corp. didn't fare much better. That issuer, which raised
capital at $25 per share two years back, offers holders exposure to a structured
credit-linked note. The pref shares, which were downgraded in April to P-3 from P-1
low in July, 2005, closed at $11 yesterday, down 75¢.
---
Ray Johnston, who runs Sherwood Financial, an Alberta-based micro-cap corporatefinance
company, isn't the happiest of campers these days, particularly as far as his
investment in Mart Resources Inc. is concerned. Mart explores for oil and natural gas
in Alberta and Nigeria. Indeed, at tomorrow's annual meeting, to be held in Calgary's
Delta Bow Valley, Johnston intends to present some of his concerns, including: - The
composition of the board. Not only does he believe the board is too small -- there are
six directors -- but he doesn't like their geographical spread, given that half of them
live outside Canada. Two of the six live in England, while the chairman, Wade
Cherwayko, lives in Lagos. Further, he argues that the board lacks independence as
only one of the directors, Leroy Wolbaum, hasn't been an officer of the company. The
other five directors include William Cherwayko, the father of the chairman. The
meeting will ask shareholders to fix the board at six members. - The lack of adequate
voting choices. Johnston would like to be given the choice of being able to vote
against the management slate, to be able to vote against each director individually
and to vote against the appointment of Meyers Norris Penny LLP as the company
auditor. (As is the norm, shareholders can either vote "for" or "withhold" on the
matter of dealing with the election of directors and appointment of auditors. The
proxy form mailed by Mart is correct.) Johnston also wants to know about the
international capability of Meyers Norris Penny LLP, an accounting firm based in
Western Canada. (Its Web site says it is an independent member of Baker Tilly
International.) - Past behaviour. Johnston wants to know more of the reasons why in
May the Alberta Securities Commission issued a cease-trade against a number of
insiders. (At the time, the company said the election in Nigeria caused delays in
preparing the financial statements.) In July, after financial statements were filed, the
cease-trade order was lifted. - More details about some of the recent financings. In
July, Mart announced it hoped to raise up to $33-million via a private placement of up
to 60 million units, with each unit consisting of a share plus half a share purchase
warrant. Mart also issued two lots of promissory notes, one secured and one
unsecured. Both notes, which were bought by private investors, mature in November,
Barry Critchley
Financial Post
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2008.
Johnston, whose business focuses on early-stage Western Canadian companies, said
he has "been an admirer of Wade Cherwayko's mission for many years. He takes high
risks in politically difficult parts of the world for potentially huge rewards. But I want
good, full and fair disclosure and a board of directors that acts in the interests of all
the shareholders. As well, the board needs more directors, including [at least] one
who is a professional accountant with audit experience."
Calls to Mart Resources weren't returned.
---
Difficult market conditions have put an end to, for the time being at least, one of the
more interesting structured products to come along in a while.
The fund is known as the Brompton 130/30 Equity Fund and was unusual because it
offered investors more choice than a traditional long-only fund that invests in the U.S.
equity market. The fund allowed for short selling of up to 30% of the portfolio. So
after investing, say, $100-million in a long-only fund, the manager -- in this case UBS
Management -- would borrow another $30-million and use the proceeds to short the
market. In this way, the original $100-million grows to $130-million while the
borrowed $30-million is on the short side. Ergo: a net $100% long exposure via
something known as 130/30 investment strategy.
Brompton couldn't be reached for comment.
bcritchley@nationalpost.com

http://www.canada.com/components/print. ... 7e1a19de87 9/15/2007

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Goldfarb missing millions in commercial debt crisis
JACQUIE MCNISH
FROM FRIDAY'S GLOBE AND MAIL
SEPTEMBER 14, 2007 AT 1:10 AM EDT
Martin Goldfarb, one of Canada's most influential political pollsters, said his company has been sideswiped by a freeze-up in the
commercial paper market and he is calling for his bank to step up and help get the funds flowing again.
Mr. Goldfarb, chief executive officer of Goldfarb Corp. [GDF.H-X] , said he has been investing most of the Toronto investment
company's cash during the past few years in asset-backed commercial paper issued by small financial players such as Coventree Inc.
[COF-T] The paper was purchased from Bank of Nova Scotia [BNS-T], which has been Goldfarb's banker for 35 years, and by July of
this year the company had invested $30-million, equal to most of its asset value, in the notes.
Mr. Goldfarb said he and the company's board believed they were prudently investing cash in short-term securities as they prepared to
wind up Goldfarb and distribute proceeds to its shareholders.
“The salesmen were telling us that this was the highest-rated paper out there and that it was backed by the banks. We believed we were
pursuing a conservative investment strategy,” said Mr. Goldfarb, the company's chief executive officer.
Goldfarb Corp.
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Mr. Goldfarb learned how wrong he was on Aug. 10 when most of the paper matured. By then a widening global liquidity crisis had
paralyzed commercial paper and many issuers could no longer raise money to pay back investors.
A few days later one of the issuers, Lafayette Structured Trust, had sufficient backing from a Swiss insurance company to buy back
$13-million of the paper owned by Goldfarb.
That left Goldfarb with $17-million of orphaned commercial paper and many questions for Bank of Nova Scotia and CEO Rick
Waugh, whom Mr. Goldfarb describes as a friend. Under a special accord signed by some of the country's biggest asset-backed
commercial paper owners, investors are restricted until mid-October from selling the notes while a special committee scrambles to
rescue more than $35-billion of securities sold by non-bank intermediaries.
In the meantime, Mr. Goldfarb said he and his chief financial officer have been unable to get any information from the bank or the
special committees administrator about the assets linked to the $17-million of commercial paper his company owns.
“There is no information anywhere. There is no transparency. I haven't heard a thing from [Mr. Waugh] or the bank. They have an
obligation to inform us and to commit to helping us get our money back.”
Mr. Goldfarb isn't alone. According to people familiar with the rescue operation, most of Canada's major banks were active sellers of
the troubled asset-backed commercial paper and a broad cross section of wealthy individuals, corporations and provincial and
municipal governments saddled with the investments are pressuring these banks to contribute to what is expected to be a lengthy and
potentially costly restructuring. The banks that actively sold asset-backed commercial paper from the troubled smaller financial
companies are Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada [RY-T], and National Bank of
Canada [NA-T]. Banks have already earned undisclosed commissions for selling commercial paper on behalf of such companies as
Coventree.
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Frank Switzer, a spokesman for Bank of Nova Scotia, said the bank does not talk about its clients. He said that the buyers of assetbacked
securities were experienced investors who were placing orders with the bank rather than seeking investment advice.
“If a sophisticated client calls our order desk and places a decision to order these securities, that is their decision,” Mr. Switzer said.
He added that the bank is also prepared to lend money at standard rates to any clients who have cash needs as result of the credit
crunch.
Mr. Goldfarb, however, said he is appalled that the banks would seek to make profits by lending money to clients during a financial
crisis.
“They are trying to take a disaster situation and make money from it,” he said.
Although bank executives have publicly said they are under no legal obligation to assist or lend money to support the commercial paper
market, a number of sources said they expect the banks to play a role once more information becomes available about the assets
underlying some of the commercial paper.
Sources said they expect that once details are available about assets linked to the commercial papers, the banks will help sell the
distressed notes to potential buyers. “The banks recognize they have to do something here,” said one bank official who declined to be
identified.
Phillip Crawley, Publisher
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