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

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Goldman Sachs ...
seemingly on both sides of the collateralized mortgage obligation deals?


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December 2, 2007
Everybody’s Business
The Long and Short of It at Goldman Sachs

Stuart Goldenberg
By BEN STEIN
FOR decades now, as a writer, economist and scold, I have been receiving letters from thoughtful readers. Many of them have warned me about the dangers of a secret government running the world, organized by the Trilateral Commission, or the Ford Foundation, or the Big Oil companies or, of course, world Jewry.

I always scoff at these letters. The world is far too complex a place to be run by any one group. But the closest I have recently seen to such a world-running body would have to be a certain large investment bank, whose alums are routinely Treasury secretaries, high advisers to presidents, and occasionally a governor or United States senator.

This all started percolating in my fevered brain last week when a frequent correspondent, a gent in Florida who is sure economic disaster lies ahead (and he may be right, but he’s not), forwarded a newsletter from a highly placed economist at Goldman Sachs named Jan Hatzius.

That worthy scholar recently wrote a detailed paper about how he thought the subprime mess would get worse and worse. It would get so bad, he hypothesized, that it would affect aggregate lending extremely adversely and slow down growth.

Dr. Hatzius, who has a Ph.D. in economics from “Oggsford,” as they put it in “The Great Gatsby,” used a combination of theory, data, guesswork, extrapolation and what he recalls as history to reach the point that

when highly leveraged institutions like banks lost money on subprime, they would cut back on lending to keep their capital ratios sound — and this would slow the economy.
This would occur, he said, if the value of the assets that banks hold plunges so steeply that they have to consume their own capital to patch up losses. With those funds used to plug holes, banks’ reserves drop further. To keep reserves in accordance with regulatory requirements, banks then have to rein in lending. What all of this means — or so the argument goes — is that losses in subprime and elsewhere that are taken at banks ultimately boomerang back, in a highly multiplied and negative way, onto our economy.

As the narrator in the rock legend “Spill the Wine” says, “This really blew my mind.”

So I started an e-mail correspondence with Dr. Hatzius, pointing out what I believed were a few flaws in his paper. Among them were his hypothesis that home prices would fall an average of 15 percent nationwide (an event that has never happened since the Depression, although we surely could be headed in that direction), and that this would lead to a drastic increase in defaults and losses by lenders.

This, as I see it, is a conclusion that is an estimation based upon a guess. I found especially puzzling the omission of the highly likely truth that the Fed would step in to replenish financial institutions’ liquidity if necessary. In a crisis like that outlined by the good Dr. Hatzius, the Fed — any postwar Fed except perhaps that of a fool — would pump cash into the system to keep lending on track.

I mentioned this via e-mail to Dr. Hatzius. He generously agreed that there was some slight merit to my arguments and that he was merely pointing out tendencies and possibilities (if I understand him correctly).

BUT forecasting is tricky, and I have a hard time believing that financial events to come will be qualitatively different from those that have already happened.

I do want to emphasize Dr. Hatzius’s gentlemanliness and intelligence. But I also want to emphasize that, as I see it, his document was mostly about selling fear. A spokesman for Goldman Sachs categorically denies this point and says that the firm’s economic research is held to the highest levels of objectivity and that its economists’ views are completely independent.

As I interpret it, Dr. Hatzius was saying that the financial system would possibly not be able to adjust to a level of financial losses that are large on an absolute scale but small compared with aggregate credit or the gross domestic product. He is also postulating that lenders would have to retrench so deeply that lending would stall and growth would falter — an event that, again, has not happened on any scale in the postwar world, except when planned by the central bank.

In other words, with the greatest possible respect to Dr. Hatzius, his paper is not really what I would call a serious overview of the situation. It is more a call to be afraid and cautious based on general principles that he embraces and not on the lessons of history. (In this respect, he is much like many economic journalists and commentators who sell newsprint by selling fear. The common cause of journalists and Wall Streeters in this regard is a subject I will address in the future.)

Now, let me make a few small points here and then get to my own big point.

Goldman Sachs is a huge name in terms of moneymaking and prestige. I totally understand the respect it receives for its financial dexterity. The firm is a superstar in that regard, and I, a small stockholder, am grateful. But it has never been clear to me exactly why its people are considered rocket scientists in any other area than making money.

Dr. Hatzius’s paper is a prime example of my puzzlement. It shows extreme intelligence but basically misses the point: yes, there are possible macro dangers, but you have to go all the way around Robin Hood’s barn to get to them, and you have to use what I think are extremely far-fetched hypotheticals to get to a scary situation. (This is not to diminish the real risks in today’s economy, I’m just not as gloomy about them as Dr. Hatzius.)

Why, then, is his document circulating? Perhaps as a token of Dr. Hatzius’s genuine intelligence, which is fine. But to me, his paper seemed like a selling document in the real Wall Street sense of selling — namely, selling short. (Dr. Hatzius notes that he has long been bearish on housing, since faraway 2006, but I respectfully note that that is a lot different from predicting a credit catastrophe. The spokesman for Goldman also noted the company’s bearishness on housing since 2006. He also noted that in the recent past, Goldman Sachs has moved to a considerably larger short posture and that the firm is net short.)

More thoughts came to me as I read a recent piece in Fortune by my colleague Allan Sloan, a veteran financial writer. Mr. Sloan traces the life and death throes of a Goldman Sachs-arranged collateralized mortgage obligation. He shows how truly toxic waste was sold to overly eager investors who now have major charge-offs, and he also points out that some parts of the C.M.O. were indeed safe and were either current or had been paid off.

But what leaps out at me from this story is that Goldman Sachs was injecting dangerous financial products into the world’s commercial bloodstream for years.

My pal, colleague and alter ego, the financial manager Phil DeMuth, culled data from a financial Web site, ABAlert.com (for “asset-backed alert”), that Goldman Sachs was one of the top 10 sellers of C.M.O.’s for the last two and a half years. From the evidence I see, Goldman was doing this for years. It might have sold very roughly $100 billion of the stuff in that period, according to ABAlert. Goldman was doing it on a scale of billions even when Henry M. Paulson Jr., the current Treasury secretary, led the firm.

The Goldman spokesman would not comment on this except to note that other firms sold C.M.O.’s too.

The point to bear in mind, as Mr. Sloan brilliantly makes clear, is that as Goldman was peddling C.M.O.’s, it was also shorting the junk on a titanic scale through index sales — showing, at least to me, how horrible a product it believed it was selling.

The Goldman Sachs spokesman said that the company routinely shorts the securities it underwrites and said that this is disclosed. He noted candidly that Goldman is much more short in this sector than usual.

Here is my humble hypothesis, even after talking to Goldman: Is it possible that Dr. Hatzius’s paper was a device to help along the goal of success at bearish trades in this sector and in the market generally? His firm says his paper, like all of its economists’ work, was not written to support any larger short-trading strategy. But economists, like accountants, are artists. They have a tendency to paint what their patrons, who pay them, want to see.

From what I have observed over the years, Goldman has a fascinating culture. It is sort of like what I imagine the culture of the K.G.B. to be. You always put the firm first. The long-ago scandal of the Goldman Sachs Trading Corporation, which raised hundreds of millions just before the crash of 1929 to create a mutual fund, then used the fund’s money to prop up stocks it owned and underwrote, was a particularly sad example. The fund, of course, went bust.

Now, obviously, Goldman Sachs does many fine deals and has many smart, capable people working for it. But it’s not the Vatican. It exists to make money for the partners and (much farther down the line) the stockholders. The people there are not statesmen. They are salesmen.

To my old eyes, the recent unhappiness about mortgages and Goldman’s connection with them are not examples of sterling conduct. It is bad enough to have been selling this stuff. It is far worse when the sellers were, in effect, simultaneously shorting the stuff they were selling, or making similar bets.

Doesn’t this bear some slight resemblance to Merrill selling tech stocks during the bubble while its analyst Henry Blodget was reportedly telling his friends what garbage they were? How different would it be from selling short the junky stock that your firm is underwriting? And if a top economist at Goldman Sachs was saying housing was in trouble, why did Goldman continue to underwrite junk mortgage issues into the market?

HERE is a query, as we used to say in law school:

Should Henry M. Paulson Jr., who formerly ran a firm that engaged in this kind of conduct, be serving as Treasury secretary?
Should there not be some inquiry into what the invisible government of Goldman (and the rest of Wall Street) did to create this disaster, which has caught up with some Wall Street firms but not the nimble Goldman?
When the Depression got under way, the government created the Temporary National Economic Committee to study just what had happened on the Street to get the tragedy going. Maybe it’s time for an investigation of just what Wall Street and Goldman did to make money as they pumped this mortgage mess into the economic system, and sometimes were seemingly on both sides of the deal.

Or is Goldman Sachs like “Love Story”? Does working there mean never having to say you’re sorry?

Ben Stein is a lawyer, writer, actor and economist. E-mail: ebiz@nytimes.com

[admin]

Here is today's media on Canaccord adding Scotia Capital as a party to a lawsuit against it by two of its clients concerning Non Bank ABCP. Also, David Dodge spoke out today about the material contracts underlying the ABCP being restricted to DBRS and not accessible to the owners. He is finally calling for new transparency regulation for structured financial products. I have decided that complex structured investment products need to be sold by prospectus with public access to material contracts, even for products only sold to pension funds, governments and corporations.

Plus, New York Attorney General Andrew Cuomo has issued subpoenas for information from three Wall Street firms about their due diligence on securitized products and their relationship with credit rating agencies.

CIBC's stock dropped 5% today upon disclosure of another C$9.3 billion of subprime mortgage exposure through derivatives contracts hedged with unnamed investment-grade counterparties. There is market concern about whether the hedge counterparties will be able to pay their default damage claims. International banks who are counterparties to the credit default swaps in Canada, should be forgiving their claims for default damages from the Non Bank ABCP owners since these material contracts and the limited use liquidity agreements signed by the same banks were not adequately disclosed to the Non Bank ABCP owners and constituted unfair dealing.

Let's hope the vendor group does the right thing and offers make whole settlements to the Non Bank ABCP owners on December 14th.

Diane Urquhart
Independent Analyst

[admin]

Scotia Capital named in ABCP lawsuits
TARA PERKINS AND JACQUIE MCNISH
FROM THURSDAY'S GLOBE AND MAIL
DECEMBER 6, 2007 AT 6:05 AM EST
Canaccord Capital Corp. is alleging that Bank of Nova Scotia received material non-public information about third-party assetbacked
commercial paper in July and began reducing its own holdings of the paper, even as it continued to pitch the investment to
clients.
The allegations have arisen as part of two lawsuits filed by investors against Canaccord in the Supreme Court of British Columbia.
Canaccord brought Scotiabank into the suits because the bank sold the ABCP to Canaccord, which in turn sold it to companies and
individual investors.
Canaccord named Scotiabank's investment banking arm, Scotia Capital Inc., as a party to the suits, alleging that it made negligent
misrepresentations, failed to warn Canaccord and breached its fiduciary duty.
Scotiabank denies each and every allegation and plans to defend itself vigorously, spokesman Frank Switzer said yesterday.
"Canaccord is a sophisticated participant in the market, they understood the nature of the products they were buying, and they didn't
rely on us for advice," Mr. Switzer said, adding that Scotia Capital was not provided with any information it considered complete or
material. "We continued to rely on the DBRS rating, which did not change, as did others, including, presumably, Canaccord," he said.
The suits are among the first of a potential wave of litigation that could hit the banks and investment dealers if the a co-operative of
investors and banks known as the Crawford Committee (initially known as the Montreal Accord) fails to successfully restructure $33-
billion of stricken ABCP into longer-term investments.
Legal sources said dozens of companies that have been stranded with troubled ABCP, structured by non-bank firms such as Coventree
Inc., are furious that their banks sold them the notes in late July and early August when there were growing signs of turmoil.
These investors have quietly prepared potential lawsuits, but they have put the claims on hold until at least Dec. 14 when the Crawford
Committee is set to unveil its proposals to restructure frozen ABCP.
Jeffrey Carhart, a restructuring specialist with Miller Thomson LLP, said his firm currently represents numerous companies that hold
hundreds of millions of dollars in ABCP. "We really, really, really want the workout process to work, but if it doesn't it stands to reason
that there is going to be litigation," he said.
The B.C. suits against Canaccord were launched by two investors, Gregory Hryhorchuk, the chief financial officer of a gold exploration
company, and First Allied Development Corp., a B.C.-based company owned by Robert Madiuk.
Each suit names Canaccord and one of its salespeople as defendants for putting more than $100,000 of the investor's money into a
third-party ABCP trust called Structured Investment Trust III (SIT III).
The suits allege Canaccord was negligent and breached its duty to the investors for several reasons, including failure to do a reasonable
study of the securities and failure to warn of the purchase risks.
None of the allegations have been proven in court.
In its defence documents, Canaccord says that it did not guarantee the success of any advice it provided and that it was not a custodian
to the investors. If those investors did incur losses, "it was the result of unexpected market occurrences, and not the fault of the
defendant," it states.
It also cites the role of other parties, including credit rating agency DBRS, which gave SIT III commercial paper the highest rating
possible. Canaccord says DBRS failed to take into account that the exposure of SIT III notes to U.S. subprime mortgages could result
in a loss of confidence by the market, and therefore a lack of liquidity.
The rating agency also failed to take into account the limitations of the emergency lines of credit arranged for the trusts, Canaccord
alleges. DBRS has not been named as a party to the lawsuits.
Canaccord also cites Coventree Inc. and its subsidiary Nereus Financial Inc., which created the SIT III trust, for failing to disclose to
Canaccord the trust's actual exposure to U.S. subprime mortgages and for failing to limit the exposure. Neither Nereus nor Coventree
have been named as a party to the lawsuits.
Scotia Capital, the lead dealer for SIT III ABCP, was named as a party.
reportonbusiness.com: Scotia Capital named in ABCP lawsuits Page 1 of 2
http://www.theglobeandmail.com/servlet/ ... alEvents2/ 12/6/2007
It "actively and aggressively marketed [the paper] to Canaccord by means of frequent or daily written and oral solicitations and
communications," Canaccord alleges.
It further alleges Scotia Capital received material information about the trust's exposure to U.S. subprime in July, and acted on that
information.
On July 24, Scotia Capital and other dealers received a Coventree e-mail disclosing some of its trusts' exposures to U.S. subprime
mortgage assets, including SIT III. Canaccord's defence alleges Scotia Capital received the same basic facts from sources before July
14.
"In or about July, 2007, Scotia Capital began to reduce, limit or eliminate its own SIT III ABCP inventory, and the SIT III ABCP
owned by Scotia Capital clients, because of Scotia Capital's knowledge of undisclosed material information concerning the U.S.
subprime exposure of Coventree sponsored ABCP," it alleges.
Between July 10 and Aug. 13, Scotia Capital began offering a higher relative rate of return on the paper, it adds. "Scotia Capital failed
to disclose its knowledge to Canaccord that the rates were higher because Coventree and Nereus conduits, including SIT III, were
experiencing increasing difficulty in finding buyers to purchase new ABCP to fund the payment of maturing ABCP."
It also says Scotia Capital had an ethical standard to resign as a seller of Coventree and Nereus paper after it allegedly received the
material non-public information in July.
CANACCORD CAPITAL (CCI)
Close: unchanged at $15.15
BANK OF NOVA SCOTIA (BNS)
Close: $52.15, down 44¢
http://www.theglobeandmail.com/servlet/ ... alEvents2/ 12/6/2007

[admin]

UPDATE 4-CIBC stock battered by hedged subprime exposure
Thursday, December 06, 2007 6:09:33 PM (GMT-05:00)
Provided by: Reuters News
(Adds CEO quotes, analyst comment, closing share price)
By Lynne Olver and Nicole Mordant
TORONTO/VANCOUVER, Dec 6 (Reuters) - Canadian Imperial Bank of Commerce <CM.TO> posted an 8 percent jump in
fourth-quarter earnings on Thursday but its stock and reputation took further hits from the U.S. housing-derived credit
crunch.
CIBC shares sank 5.4 percent in heavy volume after it revealed it expects more U.S. subprime mortgage-related
writedowns, and warned of potential "significant losses" from its hedged exposure to the troubled U.S. housing sector.
Chief Executive Gerry McCaughey, who has stressed risk-reduction measures since he took the top job in 2005, said
CIBC underestimated the meltdown of the subprime market.
"This, coupled with an over-dependence on the extremely high ratings of these securities, resulted in the build-up of
exposures that are too large for CIBC's risk appetite," McCaughey said on a conference call.
CIBC, Canada's fifth-biggest bank, said that as of Oct. 31 it had a notional C$9.3 billion ($9.2 billion) of subprime
mortgage exposure through derivatives contracts hedged with unnamed investment-grade counterparties. The fair value
of the hedged contracts was C$4 billion, the bank said.
The impact of economic and market condition changes on counterparties could mean "significant future losses," it said.
The bank "again showed its propensity to misstep," BMO Capital Markets analyst Ian de Verteuil said in a note. He said
CIBC could take another C$2 billion in subprime charges in the first half of 2008.
A number of unknowns in the release stoked fear, said Bruce Campbell, president of Campbell & Lee Investment
Management.
"The question that the market is now trying to come to grips with is what are those hedges, who are the counterparties
and how good are they?" Campbell said.
Shares in CIBC sank C$4.69, or 5.4 percent, to C$82.40 on the Toronto Stock Exchange. The stock is down 16 percent
year-to-date, the second-worst performer among Canadian banks.
CIBC has the largest exposure among Canadian banks to the U.S. subprime sector, which made home loans to customers
with poor credit records, many of whom are now defaulting.
Market conditions have worsened since Oct. 31, CIBC said, and it projected another C$225 million writedown for
November.
But analysts said the C$9.3 billion in hedged subprime derivatives contracts -- or $9.8 billion in U.S. dollar terms on Oct.
31 -- grabbed their attention.
"This is a bit more on the risk side than people were expecting out of CIBC," Edward Jones analyst Craig Fehr said. "A
primary focus for CIBC in recent quarters and going forward has been the de-risking of the bank, and this seems pretty
inconsistent with that message."
Rating agency Moody's changed the outlook on CIBC's debt to negative from stable, citing concern about risk
management. Despite expected improvements, "it now appears the bank has not fully addressed appropriate risk-taking
at a senior, strategic level," Moody's said.
Blackmont Capital analyst Brad Smith said CIBC's disclosure of its gross subprime exposure confirmed market
speculation, and he said several credit insurers have been pressured due to concerns about their ability to honor
counterparty contracts.
CIBC said nearly half its hedged portfolio with exposure to subprime real estate was spread among five triple-A rated
Page 1 of 2
reutersnews://reuters/local?cache=1440&id={65890935-442F-48AB-8121-5F68D6F9DB97} 12/6/2007
guarantors, none of which rating agencies have downgraded. But a big chunk of it, with notional value of US$3.5 billion,
was hedged with one single-A rated counterparty.
Meanwhile, CIBC said it earned a net C$884 million, or C$2.53 a share, for the three months to Oct. 31, up from yearearlier
C$819 million, or C$2.32 a share, with gains driven by its retail business.
CIBC had previously said its unhedged exposure to the subprime market was about US$1.7 billion.
It updated that figure on Thursday, saying its net unhedged exposure to collateralized debt obligations and residential
mortgage-backed securities on Oct. 31 was about C$741 million, or $784 million in U.S. dollar terms.
($1=$1.01 Canadian)
(Reporting by Lynne Olver and Nicole Mordant; Editing by Rob Wilson)

[admin]

Wall Street Firms Are Subpoenaed
New York Examines Treatment
Of Debt Tied to Risky Mortgages
By KARA SCANNELL
December 5, 2007; Page C2
New York state prosecutors have sent subpoenas to several Wall Street firms seeking information related to
the packaging and selling of debt tied to high-risk mortgages, people familiar with the matter say, the latest
legal woe to hit the stressed industry.
The subpoenas, sent by the office of New York state's attorney general, Andrew Cuomo, are broadly written
and request information from firms including Merrill Lynch & Co., Bear Stearns Cos. and Deutsche Bank AG,
people familiar with the matter say.
The review, part of a broader investigation into the mortgage industry, is examining how
adequately the investment banks reviewed the quality of mortgages before packaging
them into products that were then sold to investors, these people say. The subpoenas
also requested information about how the debt was pooled into securities, including the
banks' relationship with credit-rating firms.
A spokesman for Mr. Cuomo couldn't be reached. A Merrill spokesman declined to
comment on the subpoena, saying: "We always cooperate with regulators when asked to
do so." Bear Stearns and Deutsche Bank declined to comment.
The state-prosecutor inquiry is the latest twist in the fallout stemming from residential
subprime mortgages. A rise in defaults and foreclosures, particularly among low-end
borrowers, has whipsawed global stock and bond markets, led to the dismissal of two
Wall Street chief executives, and resulted in losses by banks, hedge funds and securities firms. The
Securities and Exchange Commission has opened about two-dozen investigations stemming from the
collapse of residential subprime mortgages, a person with knowledge of the situation said. In addition, the
role of credit-rating firms is being examined by federal and state regulators.
The role being played by Mr. Cuomo's office is reminiscent of the path taken by his predecessor, Eliot
Spitzer, who as New York attorney general shined a spotlight on conflicts of interest on Wall Street, trading
abuses at mutual funds and bid-rigging at insurance companies.
The inquiry into what role securities firms played in the current crisis is likely to look at Wall Street's
underwriting standards. In particular, the probe appears to be examining the relationships between
mortgage companies, third-party due-diligence firms, securities firms and credit-rating firms.
The inquiry raises questions about the extent to which securities firms are obligated to dig into the
mortgages before slicing them up to sell to investors. Many securities firms rely on third-party vendors to do
this work; among the questions is whether this effort was adequate, or if securities firms had a duty to do
further due diligence. Securities firms that underwrite securities have an obligation to make sure that
statements included in offering documents are accurate.
In a news conference last month announcing subpoenas to mortgage giants Fannie Mae and Freddie Mac,
Mr. Cuomo said "investment banks wanted the mortgages." That suggests he is raising questions about
whether banks turned a blind eye to what Mr. Cuomo says were inflated appraisals in order to package and
sell the products to make fees. "The follow-the-money expression is, 'follow the mortgage'" into the
secondary market, Mr. Cuomo said.
Write to Kara Scannell at kara.scannell@wsj.com

[admin]

Here's hoping report clears up financial quagmire
December 09, 2007
Ellen Roseman Toronto Star

Last June, an investor called Ron believed the stock market was overvalued and asked his adviser to sell most of his mutual funds.

"The timing seemed excellent as the market correction arrived shortly after," he says.

But Ron failed to discuss with his adviser what to do with the sale proceeds.

The money ended up in a 30-day money market investment, which was called Rocket Trust on his monthly statement.

The adviser said Rocket Trust notes had a AAA rating, better than many government bonds.

But after 30 days, the adviser called to say the funds weren't available and had to be rolled over for another six months.

"I was fine with this. The stock market was still unstable and I was looking for a safe haven," Ron says.

"But after doing a bit of research on Rocket Trust, I see it's part of the Coventree asset-backed commercial paper (ABCP) quagmire.

"How worried should I be that I am exposed to ABCP?"

This Friday, a blue-chip committee will report on its efforts to restructure Canada's $35 billion market in non-bank ABCP – mostly in trusts run by independent issuers such as Coventree Capital Group of Toronto.

The original October deadline was extended. Everyone hopes that Montreal lawyer Purdy Crawford and investment bank JPMorgan Chase will be able to wring concessions from international banks and get the market moving again.

Small investors like Ron can hardly be blamed for not knowing what they got into.

The information memorandum about Rocket Trust, available at Coventree's website, is 18 pages of bafflegab, clarifying nothing. There was no indication that any assets were linked to the U.S. subprime mortgage market.

It was easier to rely on the AAA rating conferred by Dominion Bond Rating Service, whose report is also at Coventree's website.

Only after the crisis blew up did it become widely known that DBRS was the only bond rating agency that would rate such debt. The other agencies, such as Moody's and Standard & Poor's, stayed away.

DBRS said the Rocket Trust notes had liquidity lines to cover market disruptions – a strength. It also said the liquidity lines were limited to market disruption – a challenge.

With such equivocation, how could investors or advisers rate the rating agency's AAA rating?

Only later did it become known that the liquidity backstop for these securities was less complete in Canada than elsewhere.

International banks had to buy back the assets only if there was a market disruption severe enough that commercial paper issuers could not issue anything at all. That never happened.

Ron bought his Rocket Trust notes from Credential Securities, a firm that is owned by the credit union movement in Canada.

Credit unions market themselves as more ethical and customer-friendly than banks. But even they are not immune to the money market contagion.

A merger between two of Canada's largest credit union organizations, Credit Union Central of Ontario and Credit Union Central of British Columbia, has been held up because of their holdings of ABCP.

Though the amounts were small ($161 million for Ontario and $23 million for B.C. out of total assets of $7.5 billion), no one could put a price tag on the ABCP portfolios because the market is frozen. So the merger has been put off from the original date of Oct. 1, 2007.

Meanwhile, Coventree has had to make major cuts in its workforce to trim costs. Its stock is trading at just $1 – or 94 per cent below its 52-week high of $16.30.

All eyes will be on Montreal this week when the committee releases its report. Let's hope the uncertainty that has lingered since August will finally start to clear up.



--------------------------------------------------------------------------------
Ellen Roseman's column appears Wednesday, Saturday and Sunday. You can reach her by writing Business c/o Toronto Star, 1 Yonge St., Toronto M5E 1E6; by phone at 416-945-8687; by fax at 416-865-3630; or at eroseman@thestar.ca by email

[admin]

The December 12, 2007 National Post article, "David Dodge Sounds Alarm," quotes the Governor of the Bank of Canada as follows:
"All Canadians could pay a price if banks fail to come up with an agreement to save the troubled sector of the country's debt market and $300-billion worth of leverage is allowed to unwind in a worst-case scenario, David Dodge, governor of the Bank of Canada, said yesterday. If the whole market goes into a shambles everybody gets affected, including Mr. and Mrs. Jones on Main Street," said Mr. Dodge. "We have a collective interest in the whole thing not going into a shambles."

In my opinion, the banks should offer the solution, where they take the newly restructured long term notes and they offer cash settlements to the current owners at par, (except for the Caisse due to its dominance in the Non Bank ABCP market and its conflict of interest as an owner of Coventree and modest discounts for ABCP Series Notes not backed by any liquidity agreement). Then, the banks can take possession of, on their own balance sheets, the AAA rated collateral assets and the leveraged credit default swap liabilities under settlement arrangements amongst themselves, that avoids the fire sale of $300 billion worth of AAA rated collateral assets and CDS reference AAA asset portfolios. The banks should upon taking the restructured long term notes onto their own balance sheets, take the marked to market writedowns on the underlying net assets. As noted in my independent research report, "Another Made-in-Canada Defective Investment Product," dated November 23, 2007, the banks can afford to take the writedowns, as the after tax loss would likely be between -4% and -8% of their total shareholders equity.

The banks agreeing to this solution, that I illustrate by schematic above, would demonstrate the same leadership that J.P. Morgan exhibited in the U.S. Financial Panic of 1907, where the major U.S. banks agreed to bailout several trusts that were suffering runs by depositors, who feared the loss of their money when the net assets within the trusts were becoming impaired in value. These U.S. banks volunteered to make the trust depositors whole even when they had no legal obligation to do so. In the current Canadian Non Bank ABCP crisis, the ABCP short-term lenders are akin to the depositors in the trusts during the Financial Panic of 1907. The difference in circumstances within Canada today, is that the domestic banks(excluding possibly the TD Bank) and the foreign divisions of international banks were themselves, or their subsidiaries, directly involved in the manufacturing or distribution of the frozen Non Bank ABCP that were designed and sponsored by entrepreneurial conduit firms. Some Canadian banks and the list of international banks in the Montreal Accord became involved in the manufacturing of the Non Bank ABCP trusts, when they became buyers of the leveraged credit default swaps or the signatories for the "no use" liquidity agreements. In most cases, the bank who bought the credit default swaps with the claims for default damages and subsequent rights to the AAA collateral assets, was the same bank that signed the "no use" liquidity agreements. This simultaneous contracting by the banks was not fair dealing and not disclosed to the Non Bank ABCP owners.

The banks offering the solution I suggest is not a case comparable to J.P. Morgan organizing a bank bailout of trusts that they were not legally required to do. Owners of the Non Bank ABCP today do have legitimate legal claims for remedy from the banks for negligent misrepresentation related to the manufacturing or distribution of the Non Bank ABCP trusts. If J.P. Morgan and the banks existing in 1907 had the where with all to make a voluntary bailout of the trusts, when they had no legal obligation to do so, to avoid a financial crisis, surely the Canadian and international banks that have legal liability for their direct or subsidiary involvement with the Canadian Non Bank ABCP trusts can step to the plate to come up with an agreement with Canadian pension funds, governments and corporations that are stuck with this defectively designed commercial paper of uncertain current value.

The way I see it, just because the securities guard is asleep does not mean you are entitled to rob the bank. The pension fund portfolio managers, government and corporation treasurers could have asked more questions, but the banks should not have sold a product negligently or with deceit that has Canadian pension beneficiaries, shareowners and taxpayers being robbed of their cash. The money managers and treasurers working for Canadians did not invest in money market instruments for high investment returns, but to achieve capital preservation while they waited for its long term deployment in corporate projects, public infrastructure and services and the purchase of long term investments such as stocks, bonds and real estate.

Diane Urquhart
Independent Analyst

[admin]

I have the following observations on the National Post article "ABCP restructuring will happen one way or another, Purdy Crawford," dated December 15, 2007 and on the White Knight Investment Trust DBRS Description, dated December 11, 2007:

(1) The Pan Canadian Committee asking the banks to take responsibility for as much as $10 billion of collateral calls, suggests to me that the damages in the $33 billion face amount of Non Bank ABCP under the Montreal Accord are about $10 billion or a loss of -30%. -30% is smack in the middle of my estimated loss range of -20% to -40% (or $7 to $13 billion) for the Non Bank ABCP trusts under the Montreal Accord. I made the -20% to -40% estimated loss range in the attached independent research report, "Another Made-in-Canada Defective Investment Product," now updated to December 17, 2007 and consolidated for all of the new developments and research done, since I first wrote this report on September 24, 2007. These loss estimates are before accommodating settlement offers from the vendor group, which I say should occur given that the vendor group had to know about the defects in the Non Bank ABCP in general and may have had specific adverse information at the time of sale that was not known to the Non Bank ABCP buyers. Just because the gatekeepers may have been trusting or asleep, does not mean the vendor group can rob Canada's pension funds, and government and corporation treasuries.

(2) Non Bank ABCP owners are unlikely to accept the restructured long term notes in exchange for their ABCP, unless the banks pay for all or a substantial portion of the credit default swap liabilities and expected U.S. subprime mortgage defaults within the 22 Non Bank ABCP trusts.
Canadian pension fund managers and government and corporation treasurers did not invest in money market instruments for high investment returns, but to achieve capital preservation while they waited for its long term deployment in corporate projects, public infrastructure and services and the purchase of long term investments such as stocks, bonds and real estate. The buyers were told the Non Bank ABCP was safe and had top credit ratings.



(3) The breakdown in negotiations is occurring as the domestic investment bank distributors and the international and domestic banks involved in the manufacturing of the Non Bank ABCP funded trusts duke it out on who is the cause of the crisis and who is responsible for paying the damages to the Non Bank ABCP investors. The international and domestic banks became involved in the manufacturing of the Non Bank ABCP funded trusts by being counterparties to leveraged credit default swaps and signatories to the "no use" liquidity agreements. Top quality assets, bank liquidity agreements and top credit ratings are essential ingredients to make the Non Bank ABCP saleable to Canada's pension funds, government and corporations.

(4) The White Knight Investment Trust DBRS Description dated December 11, 2007 provides some precedent for the accommodations made by bank signatories of liquidity agreements in the Skeena Trust: Royal Bank, Scotiabank, HSBC Bank and ABN Ambro. It says: "Even though all of the Trusts Asset Interests will consist of highly leveraged structured synthetic investments (such as collateralized debt obligations (CDOs)), the Trust is not subject to any collateral calls from the buyers of protection that are swap counterparties to the Trust.

It is somewhat confusing what the exact accommodation from the banks is "Since the Trusts Asset Interests will consist of highly leveraged structured synthetic investments (leveraged super-senior CDO tranches), the Trust could be exposed to a higher severity of loss should losses rise substantially in excess of AAA stress-case scenarios. Losses incurred on the Asset Interests will reduce the principal amount on the Floating Rate Notes" Does this mean there are no collateral calls during the interim of the notes term, but such collateral calls will occur on the maturity date? Who would want to own a note with such high end of period principal risk, when the cash offer in the Skeena Trust is reported to be 98 cents on the dollar?

National Post - "ABCP Restructuring will happen one way or another, Purdy Crawford," dated December 15, 2007, says:
Sources say Mr. Crawford tried to persuade the institutions that sold the CDOs to eliminate the triggers for margin calls but he was unsuccessful.

Under a new strategy, he has asked the big five banks to assume responsibility for the margin calls. That would take of the risk off investors and increase the value of the notes.

Sources said the Bank of Canada has thrown its weight behind the idea and has been "twisting the arms" of the banks to get them to sign on. However the banks are said to be reluctant.

Talks reached an impasse late last week when the banks dug in their heels. They say they shouldn't have to shoulder that responsibility for margin calls because they did not create the problem.

"Various banks have different motives for participating," he said. "All I can tell you is that they are now fully engaged at a senior level."

A source close to the negotiations said the Crawford committee wants the banks to take responsibility for as much as $10-billion of collateral calls.

White Knight Investment Trust - DBRS, dated December 11, 2007 says:

 The Asset Interests of White Knight Investment Trust (the Trust) are term-matched to the notes issued by the Trust.
 Even though all of the Trusts Asset Interests will consist of highly leveraged structured synthetic investments (such as collateralized debt obligations (CDOs)), the Trust is not subject to any collateral calls from the buyers of protection that are swap counterparties (the Swap Counterparties) to the Trust.

 Since the Trusts Asset Interests will consist of highly leveraged structured synthetic investments (leveraged super-senior CDO tranches), the Trust could be exposed to a higher severity of loss should losses rise substantially in excess of AAA stress-case scenarios.

 Losses incurred on the Asset Interests will reduce the principal amount on the Floating Rate Notes (the Notes).

 The Trust is subject to ratings volatility due to its exposure to numerous non-investment-grade credits in the underlying CDS portfolios.

 Enforcement of Events of Default is subject to a number of non-market-standard provisions due to the unique structure of this transaction.


Diane Urquhart
Independent Analyst

[admin]

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December 20, 2007
$9.4 Billion Write-Down at Morgan Stanley
By LANDON THOMAS Jr.
Morgan Stanley reported the first quarterly loss in its 72-year history Wednesday, heightening fears that the financial toll would keep mounting from the fast-spreading crisis in the subprime mortgage market.

The company took a $9.4 billion charge on subprime-linked investments for the fourth quarter, bringing its cumulative charges for subprime mortgages to $10.8 billion. In a stark reflection of its diminished status it also said it would sell a $5 billion stake to a Chinese investment fund to shore up its capital.

Wall Street banks so far have reported more than $40 billion of losses as a result of the crisis in the mortgage market. Worst-case estimates put the eventual bill at $200 billion or more. The tally is likely to rise again Thursday when Bear Stearns is expected to report a quarterly loss.

The developments on Wednesday were a stunning turn of events for Morgan Stanley, an offshoot of the Morgan banking dynasty that has counseled corporate America since the Depression. John J. Mack, the bank’s chief executive, said he took full responsibility and would forgo a bonus for 2007.

Like Citigroup and UBS of Switzerland, Morgan Stanley has turned to a wealthy investor from the East after losing billions of dollars on subprime-tainted investments. Morgan Stanley lost $3.59 billion for the fourth quarter. It said its remaining subprime exposure was $1.8 billion.

The drastic losses may heighten speculation about the fate of Mr. Mack, who returned to the firm in 2005 after the removal of his predecessor, Philip J. Purcell. One of Mr. Mack’s signature changes was to push the firm further into trading using its own capital, an effort to emulate its profitable archrival, Goldman Sachs. His strategy worked for a while but then backfired when trades in tricky subprime-linked securities went wrong, resulting in the biggest write-down in the firm’s history. While Mr. Mack is expected to keep his job, his compensation will plummet — one of the harshest punishments meted out on Wall Street, short of showing an executive the door. Last year, he made $40 million; this year, he will take home about $800,000. His paycheck is particularly humiliating since Lloyd C. Blankfein, the chief executive of Goldman Sachs, is likely to receive a $70 million bonus. James E. Cayne, the chief executive of Bear Stearns, is also expected to forgo a bonus.

In a conference call on Wednesday, Mr. Mack was quick to take responsibility. “The results are embarrassing for me and the firm,” he said.

But he also pointed out that the bulk of the $9.4 billion loss occurred on one trading desk and that other areas of the firm, particularly the investment banking, asset management, retail brokerage and hedge fund servicing businesses, performed well.

As for the investment from China, Mr. Mack framed the transaction not as a desperate act but as a strategic move. And he refused to concede that Morgan Stanley was a weakened firm. “We remain bullish on Morgan Stanley’s significant growth potential,” he said.

Still, the investment shows how reliant Morgan Stanley and Wall Street are on foreign funds and gives additional credence to the joke now circulating on trading floors: “Shanghai, Dubai, Mumbai or goodbye.”

The fund, the China Investment Corporation, has agreed to purchase almost 10 percent of Morgan Stanley; it will have no role in the management of the firm.

Citigroup recently sold a stake to a Middle East fund.

The deal is an abrupt shift in strategy for China’s $200 billion sovereign fund and underlines the extent to which it appears to be under the direct control of the country’s leaders.

Morgan Stanley executives first began discussing an investment with the fund this summer, but it was not until recently that the deal was struck.

For Morgan Stanley, the terms are severe. The firm will pay annual interest of 9 percent on bonds that will be convertible into Morgan Stanley stock in 2010.

The China Investment Corporation is under the control of China’s finance ministry, with some influence as well from the People’s Bank of China, the country’s central bank. There has been discussion in the Chinese government over whether even more foreign currency should be injected into the investment fund, as the People’s Bank of China continues to accumulate $1 billion a day as it buys up dollars to prevent the value of China’s currency from rising in international markets.

The loss at Morgan Stanley highlights a sense of strategic confusion within the firm. Going back to the firm’s early days when it broke off from the Morgan Bank, Morgan Stanley’s strength has been its investment banking and advisory business areas; both did well this year.

Mr. Mack, however, was eager to strike a more aggressive pose when he took over from Mr. Purcell, who had been criticized for his cautious approach. By encouraging his traders to take on more risk, Mr. Mack plunged Morgan Stanley into a complex, sophisticated and dangerous area that has never been a core area of competence for the firm.

In the conference call, Mr. Mack confronted tough questions from analysts.

“How could this happen?” asked William F. Tanona, an analyst with Goldman Sachs. “How could one desk lose $8 billion?”

Mr. Mack, generally a brash, expansive man, struck a chastened tone. He said the firm would be dialing back from making big trading bets.

“We had been sprinting,” he said. “Now we will be jogging. But we are in a risk business, and we will be in the market taking risk.”

Mr. Mack blamed the firm’s inadequate risk-monitoring procedures and said the firm’s risk managers would now report to the chief financial officer, which is the practice at Goldman Sachs. Previously the risk managers had reported to Zoe Cruz, the co-president overseeing trading, who was ousted by Mr. Mack last month, a further indication that the firm’s big bets lacked objective risk oversight.

Investors, while upset over the loss, seemed to be giving Mr. Mack the benefit of the doubt. Shares of Morgan Stanley’s rose $2.01, to $50.08.

“He can’t have another screw-up,” Brad Hintz, a securities analyst at Sanford C. Bernstein & Company, said of Mr. Mack. “But the clients I have talked to have not been calling for his scalp.”

Morgan Stanley had previously said it would take a $3.7 billion write-down from the trading. Now, the total loss from that trading is $7.8 billion. Morgan Stanley reported an additional $1.2 billion in write-offs from nonperforming loans. The total loss wiped out fourth-quarter revenue. For the year, Morgan Stanley has taken nearly $11 billion in trading and subprime-related charges.

Other Wall Street firms have ousted their chief executives after such losses. Charles O. Prince III of Citigroup and E. Stanley O’Neal of Merrill Lynch lost their jobs over escalating subprime write-downs.

By all accounts, Mr. Mack still has the support of his board, which includes four holdovers from the Purcell era. And unlike Mr. Prince and Mr. O’Neal, who were to some extent outsiders, removed from the culture of their respective firms, Mr. Mack, has ties to the firm’s glory days in the 1970s and 1980s and with his ability to charm, he is still liked within the firm.

In addition to keeping his board fully briefed, Mr. Mack has also reached out to the former executives who led the campaign to oust Mr. Purcell. On Wednesday, he called Robert Scott, a retired senior executive of Morgan Stanley, and briefed him on the results.

“We are here to help,” said Mr. Scott, according to a person who was briefed on the call.

For the moment, the board seems to be in no position to force Mr. Mack from his job. Not only is he well liked, but he also has no ready successor and as the protracted search for a Citigroup head demonstrated, there is a dearth of outside executives ready and willing to take on such a job.

Keith Bradsher contributed reporting.

[admin]

Sunday, December 23, 2007

Wall Street bulls should have known better than to charge into sub prime fiasco

By ERIC MARGOLIS, TORONTO SUN

Western nations have been rightly scourging China for flooding world markets with toxic food, toys, nutritional products, clothing and other tainted goods. China's government closed its eyes to this apparent malefaction.

Meanwhile, Wall Street was exporting toxic financial instruments called sub prime mortgages around the globe. Washington's regulatory monkeys saw no more evil than those in Beijing.

Here's how the sub prime mess developed. A single mother, say in East St Louis, was peddled an initially low interest adjustable mortgage by a flim-flam broker. When rates rose sharply, she couldn't pay and was forced to abandon the home she should never have bought to begin with. Multiply this little human tragedy by hundreds of thousands, and, voila, the spreading sub prime mortgage crisis.

Meanwhile, the world's leading financial institutions built a $500 billion to $1 trillion house of cards based on these sleazy mortgages. They were bundled, chopped up like stolen cars, and peddled everywhere as secure, high-yielding American securities.

Once the sub prime crisis broke, banks holding such paper panicked. Not only couldn't they find any more stupid buyers, the wildly inflated values given to these securities turned out to be totally bogus. This, in turn, gravely undermined the asset base of lending institutions holding this worthless paper.


Britain's Northern Rock (aka "Northern Wreck") suffered a run on the bank and is now clinically dead. CIBC lost up to $2 billion. Two of the world's biggest banks, Citigroup and UBS, lost $9 billion and $10 billion respectively. They nearly capsized, and had to be rescued by Gulf Arabs and Singapore. Merrill Lynch and Morgan Stanley each face $9-10 billion of write-downs. More banks will soon reveal billions of losses, all thanks to "innovate finance."

BLEW IT

How could so many of the brightest Wall Street financiers, who claim unrivaled expertise in managing clients' assets, be so stupid and incompetent?

After the flu and bad taste, few diseases are more contagious than greed. So began the greed stampede as Wall Street bulls charged into the sub prime Valley of Death.

Blame begins with the Bush administration. Faced with hugely expensive foreign wars and the dot com bubble, the White House got the Federal Reserve to lower interest rates to nearly nothing. This produced the monster property bubble that is now bursting. Cheap credit became a dangerous drug, financial "speed" arousing false economic euphoria that helped keep Republicans in power and fueled swarms of unregulated, parasitic hedge funds.

Rock-bottom U.S. interest rates made bankers and investors search out higher paying investments. sub prime mortgages were Wall Street's answer. In a giant Ponzi scheme, new investor money was used to pay off old investors, building a giant pyramid that collapsed this past fall.

The U.S. Federal Reserve, which is supposed to regulate mortgages, failed in its duty. So did other U.S. financial regulators, such as Treasury and the SEC. They, and auditing firms, allowed banks to egregiously misvalue their mortgage holdings and create "conduits" and "off balance sheet" vehicles that were new forms of accounting fraud.

COMPLEXITY

Many bankers and managers simply failed to understand the mind-numbing complexity of financial derivatives. President George Bush lauded "the new finance" as the model of Republican economic policy. It turned out to be the financial equivalent of Iraq. Worryingly, no one knows how much the world's rickety financial structure now depends on these arcane financial alchemies. We enter 2008 threatened by the prospect of new financial earthquakes and recession.

Instead of facing fraud indictment, CEOs of the big peddlers of this worthless junk got millions worth of golden handshakes, or raises. While government was busy prosecuting Conrad Black over a few million dollars, the public was defrauded of tens of billions. No one has yet been prosecuted for these outrageous crimes.

If there was a time for government to justify its existence, it's now. Prosecute the sub prime fraudsters. Forget golden handshakes. They deserve steel handcuffs.

[admin]

Here is one possible reason why Canada is gaining an international reputation of being the "financial tainted goods" manufacturer of the world:

The Purdy Crawford - Ernst & Young - J.P. Morgan restructuring solution for Canadian Non Bank ABCP is contrary to what is going on in the rest of the world. Everywhere else, "if you sold it and it breaks, you own it." See today's January 6, 2008 New York Times article, "Testing Investors' Faith in State Street," for more on this logical mantra. Where are the participating banks taking back their defective Non Bank ABCP or the underlying assets and liabilities within the frozen trusts? Where are the accommodations that Purdy Crawford says the banks are making in the restructuring offers?

New margin facility credit with high fees and interest costs and first priority to collateral assets appear to achieve the following objectives:
(1) ensure the risks fully remain with the current Non Bank ABCP owners, completely opposite to the mantra, " If you sold it and it breaks, you own it."
(2) have you take on new credit at high fees and interest rates, that is very profitable and low risk to the banks.
(3) have you waive your right to litigation against the vendor group, despite likely marked to market losses in the short and long term.
(4) provide you the hope for less marked to market losses in the future and certainly no assurance that your interest and principal are safe as you were told at the time you purchased the Non Bank ABCP.
(5) possibly give you the opportunity to understate the current market to market losses on your Non Bank ABCP by the collective and unverifiable delusion that the long term notes will be worth their face amount five or more years from now.

This is why it is so important for Non Bank ABCP owners to act collectively to force the underlying material contracts to be released to bona fide alternative solution providers, such as new fixed income buyers making cash or in kind bids, or offers to conduct orderly liquidations of the underlying assets and CDS liabilities within the frozen trusts. Purdy Crawford is playing a game of Russian Roulette with Canada's pension funds and governments, wherein he will delay release of the underlying material contracts until the last minute permitted before the votes, if they are released at all? It certainly appears to me that Purdy Crawford's decisions are based on protecting the bank CDS counterparties and liquidity agreement signatories and the investment bank distributors from litigation. His tactics to persuade the Non Bank ABCP owners to take the proposed restructuring settlement offer of: accepting losses, paying high interest costs and fees for new bank credit and waiving litigation rights, or be left with nothing, begs for an alternative and transparent solution.

Diane Urquhart
Independent Analyst

[admin]

Investing: Bad paper
Al Rosen
From the November 19, 2007 issue of Canadian Business magazine
I hope you’ve been watching the fallout from the latest Canadian-made financial fiasco. Since mid-August, the market for non-bank asset-backed commercial paper(ABCP)has been frozen, meaning holders of the investments can’t get their money out. The Canadian non-bank ABCP market has been estimated at a total of $34 billion, and some major public companies are large holders of the illiquid paper. National Bank of Canada has roughly $2 billion, Nav Canada has $368 million, Transat has $155 million, and the list goes on. For the time being, enough major players have agreed to stand pat while a national restructuring effort is underway. Nevertheless, those companies now face taking some significant writedowns. A return to liquidity simply will not restore full value to the investments.

ABCP was previously thought to be a highly liquid cash investment that offered a few basis points of interest more than alternatives such as banker’s acceptances. Few holders of the paper, however, understood the significant risk that accompanied the marginally higher investment return.

ABCP is short-term paper issued to fund investments in longer-term assets such as car loans, mortgages and various types of credit receivables. As it turns out, many were also highly invested in credit default swaps providing excessive leverage and risk. For investors to be paid out on their ABCP holdings, new ABCP must be issued(called a rollover).



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Back to my point, it should be noted that the Canadian and U.S. markets have some notable differences. While apparently not much of the Canadian paper had direct exposure to sub-prime U.S. assets(which have been defaulting in record numbers), the opacity of the ABCP caused investors to balk. Basically, no new investors could be found to roll over the paper to fund the longer-term assets. At that point, the safety net should have kicked in, and Canadian and international banks should have provided the funds to keep the process rolling, as many Canadian investors assumed they had agreed to.

Instead, the banks took a page from the insurance industry, similar to when you pay premiums for years, and your insurer screws you over when disaster finally hits. The banks, despite collecting the fees when times were good for providing the liquidity backstops(necessary for good credit ratings on the ABCP), basically told investors to suck it up. But only in Canada, that is.

In Canada, the backstop agreements contained an out for the banks, unlike in the U.S. and internationally. They only had to provide the liquidity in the event of a general market disruption, which they collectively decided had not occurred. Adding insult to injury, some of the Canadian banks that refused to provide the liquidity were the same banks that had sold the ABCP to their customers.

Which brings us to today. It’s three months into the process, and many holders of the ABCP have no idea what it’s worth. Canadian Pacific Railway recently wrote down the value of its ABCP by nearly 15%, Sherritt by 10% and Cameco by 15%. Other holders, such as HSBC Bank Canada, have taken “immaterial” writedowns on their ABCP holdings. Of course, HSBC is being sued by at least one company that says the bank misled it about the nature of the investments, so you might regard the bank’s estimated impact as somewhat tainted.

I happen to think 20% is a reasonable discount to apply in valuing the ABCP today, given the dearth of transparency, the proposed restructuring makeup, and the liquidity needs of some current holders. Applying that to the $34 billion total means that someone is responsible for a $7-billion Canadian-made goof.

So far, DBRS(which provided the top-tier credit ratings on the failed paper)has escaped unscathed. And the regulator of Canadian banks, the Office of the Superintendent of Financial Institutions of Canada, has blamed foreign banks for the freeze-up. My bet is that nobody ever takes the fall for this one, and we continue to pretend nothing is wrong with investor protection in Canada. What’s another $7 billion anyhow?

[admin]

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January 12, 2008
Inquiry Looks at Withholding of Loan Data

Andrew Councill for The New York Times
Andrew Cuomo, the attorney general of New York State, with a deputy counsel,
Benjamin Lawsky, right. Mr. Cuomo’s office has been reviewing how banks
bundle subprime mortgage loans.
By VIKAS BAJAJ and JENNY ANDERSON
An investigation into the mortgage crisis by New York State prosecutors is now focusing on whether Wall Street banks withheld crucial information about the risks posed by investments linked to subprime loans.

Reports commissioned by the banks raised red flags about high-risk loans known as exceptions, which failed to meet even the lax credit standards of subprime mortgage companies and the Wall Street firms. But the banks did not disclose the details of these reports to credit-rating agencies or investors.

The inquiry, which was opened last summer by New York’s attorney general, Andrew M. Cuomo, centers on how the banks bundled billions of dollars of exception loans and other subprime debt into complex mortgage investments, according to people with knowledge of the matter. Charges could be filed in coming weeks.

Related
Times Topics: Mortgages and the Markets
Enlarge This Image

Uli Seit for The New York Times

A foreclosure sign in Queens. The state and others
are studying the role of Wall Street banks in enabling
the mortgage boom that led to a sharp rise in defaults
and foreclosures.
In an interview Thursday, Connecticut’s attorney general, Richard Blumenthal, said his office was conducting a similar review and was cooperating with New York prosecutors. The Securities and Exchange Commission is also investigating.

The inquiries highlight Wall Street’s leading role in igniting the mortgage boom that has imploded with a burst of defaults and foreclosures. The crisis is sending shock waves through the financial world, and several big banks are expected to disclose additional losses on mortgage-related investments when they report earnings next week.

As plunging home prices prompt talk of a recession, state prosecutors have zeroed in on the way investment banks handled exception loans. In recent years, lenders, with Wall Street’s blessing, routinely waived their own credit guidelines, and the exceptions often became the rule.

It is unclear how much of the $1 trillion subprime mortgage market is composed of exception loans. Some industry officials say such loans made up a quarter to a half of the portfolios they saw. In some cases, the loans accounted for as much as 80 percent. While exception loans are more likely to default than ordinary subprime loans, it is difficult to know how many of these loans have soured because banks disclose little information about them, officials say.

Wall Street banks bought many of the exception loans from subprime lenders, mixed them with other mortgages and pooled the resulting debt into securities for sale to investors around the world.

The banks also did not disclose how many exception loans were backing the securities they sold. In prospectuses filed with regulators, underwriters, in boilerplate legal language, typically said the exceptions accounted for a “significant” or “substantial” portion. Under securities laws, banks must disclose all material facts about the securities they underwrite.

“Was there material information that should have been disclosed to investors and/or ratings agencies which was not? That is a legal issue,” said Howard Glaser, a consultant based in Washington who worked for Mr. Cuomo when he was secretary of the Department of Housing and Urban Development in the Clinton administration.

Mr. Blumenthal said the disclosures offered by banks in their securities filings appeared to be “overbroad, useless reminders of risks.”

“They can’t be disregarded as a potential defense,” Mr. Blumenthal said. “But a company that knows in effect that the disclosure is deceptive or misleading can’t be shielded from accountability under many circumstances.”

Under Connecticut law, Mr. Blumenthal could bring only civil charges in his inquiry. In New York The Martin Act in New York gives the attorney general broad powers to bring securities cases, and Mr. Cuomo could bring criminal as well as civil charges.

Mr. Cuomo, who declined to comment through a spokesman, subpoenaed several Wall Street banks last summer, including Lehman Brothers and Deutsche Bank, which are big underwriters of mortgage securities; the three major credit-rating companies: Moody’s Investors Service, Standard & Poor’s and Fitch Ratings; and a number of mortgage consultants, known as due diligence firms, which vetted the loans, among them Clayton Holdings in Connecticut and the Bohan Group, based in San Francisco. Mr. Blumenthal said his office issued up to 30 subpoenas in its investigation, which began in late August.

Officials at Wall Street banks and the American Securitization Forum, which represents industry, declined to comment, as did the due diligence firms. Credit-rating firms would not say if they had been subpoenaed but said that they were generally not provided due diligence reports, even when they asked for them.

The S.E.C. is also examining how Wall Street banks sold complex mortgage investments. The commission has about three dozen active investigations in the area, said Walter G. Ricciardi, the deputy director of enforcement. “We have not yet concluded whether the securities laws were broken,” he said.

Investment banks that buy mortgages require lenders to maintain standards outlining who is eligible for loans and how much they can borrow based on their overall credit history. But as home prices surged, subprime lenders, which market to people with weak credit, relaxed their guidelines. They began lending to people who did not provide documents verifying their income — so-called no-doc loans — and made exceptions for borrowers who fell short of even those standards.

The New Century Financial Corporation, for instance, waived its normal credit rules if home buyers put down large down payments, had substantial savings or demonstrated “pride of ownership.” The once-highflying lender, based in Irvine, Calif., filed for bankruptcy last year.

William J. McKay, who was the chief credit officer at New Century, said the company usually made exceptions so homeowners could borrow more money than they qualified for under its rules. In most cases, the decisions raised borrowers’ credit limits by 15 percent, he said.

New Century measured pride of ownership in part by how well buyers maintained their homes relative to their neighbors, Mr. McKay said, adding that this usually was not enough on its own to qualify a borrower for an exception.

Investment banks often bought the exception loans, sometimes at a discount, and packaged them into securities. Deutsche Bank, for example, underwrote securities backed by $1.5 billion of New Century loans in 2006 that included a “substantial” portion of exceptions, according to the prospectus, which lists “pride of ownership” among the reasons the loans were made.

Nearly 26 percent of the loans backing the pool are now delinquent, in foreclosure or have resulted in a repossessed home; some of the securities backed by the loans have been downgraded.

Mr. McKay defends the lending and diligence practices used in the industry. He said Wall Street banks examined exception loans carefully and sometimes declined to buy them. But they often bought them later among mortgages that New Century sold at a discount, he said.

Some industry officials said weak lending standards, not exceptions, were largely to blame for surging defaults. “The problem is not that those exceptions are going bad — you don’t have a lot of exceptions in the pools,” said Ronald F. Greenspan, a senior managing director at FTI Consulting, which has worked on the bankruptcies of many mortgage lenders. “To me it’s a more fundamental underwriting issue.”

To vet mortgages, Wall Street underwriters hired outside due diligence firms to scrutinize loan documents for exceptions, errors and violations of lending laws. But Jay H. Meadows, the chief executive of Rapid Reporting, a firm based in Fort Worth that verifies borrowers’ incomes for mortgage companies, said lenders and investment banks routinely ignored concerns raised by these consultants.

“Common sense was sacrificed on the altar of materialism,” Mr. Meadows said. “We stopped checking.”

And as mortgage lending boomed, many due diligence firms scaled back their checks at Wall Street’s behest. By 2005 , the firms were evaluating as few as 5 percent of loans in mortgage pools they were buying, down from as much as 30 percent at the start of the decade, according to Kathleen Tillwitz, a senior vice president at DBRS, a credit-rating firm that has not been subpoenaed. These firms charged Wall Street banks about $350 to evaluate a loan, so sampling fewer loans cost less.

Furthermore, it was hard for due diligence firms to investigate no-doc loans and other types of mortgages that lacked standard documentation.

“Years ago, it used to be, ‘Did the due diligence firm think it was a good loan?’ ” Ms. Tillwitz said. “We evolved into the current form, which is, ‘Did I underwrite these loans to my guidelines, which can sometimes be vague and allow exceptions?’ ”

The attorneys general are leaning heavily on due diligence firms to provide information that could prove damaging to their clients, the investment banks.

These firms played such a critical role in the mortgage securities business that New Century set aside up to eight large conference rooms in its offices where due diligence experts reviewed loan files. With billions of dollars worth of loans being traded monthly, these specialists had to keep up with a frenetic pace.

“There was somebody in most of the rooms all the time,” Mr. McKay said.

Federal lawmakers have highlighted due diligence in mortgages as a potential problem. A bill by Representative Barney Frank, Democrat of Massachusetts, that the House passed last year would require federal banking regulators and the Securities and Exchange Commission to create due diligence standards. Another measure introduced by Senator Christopher J. Dodd, Democrat of Connecticut, would subject banks to class-action lawsuits unless diligence was conducted by an independent firm.

In recent months, Moody’s and Fitch have said that they would like to receive third-party due diligence reports and that the information should be provided to investors, too. Glenn T. Costello, who heads the residential mortgage group at Fitch, said his firm would not rate securities that include loans from lenders whose procedures and loan files it was not allowed to review.

[admin]

the ACBP crisis reminds me of the tainted dog food crisis that came out of China lately.

Both crisis came about due to manufacturers who determined that by "blending" a certain amount of bad product into the manufacture process, they could fill up the quantity of manufactured goods, and hopefully no one would ever know about the blending in of garbage. (or worse)

In the pet food crisis, we all saw the outcome of unregulated manufacturers gone wild. In the ACBP crisis, we are also witnessing similar outcomes. Previous to that we saw 60 or 70 income trust products that fell into similar traps of manufacturer greed. Simulateously we are witness to massive movements of client assets towards "house branded" proprietary mutual funds. Because of an increase in quality of these products? Or because, according to the OSC, there is a revenue increase between "twelve to twenty six times" when assets are converted to house brand funds?

Thankfully, the United States is developed to the point where fraud can be objectively examined, and attempts made to prosecute and correct. Here in Canada, we are still leading the race for last place among developed nations. We allow a small number of wealthy financial interests to control not only the game, but the regulatory process, the rules, the exemptions to the rules, the enforcement or lack of enforcement, etc. The good news is that if you are among the inner circle or a provider of services to same, you will share in $30 to $60 billion in annual spoils. The bad news is that average Canadians pay this amount each and every year in the form of a Canadian discount.

[admin]

Wall Street faces fury over subprimes as
regulators and cities file lawsuits
Published: Monday, February 18, 2008 | 5:30 PM ET
Canadian Press: Mark Jewell, THE ASSOCIATED PRESS
BOSTON - Regulators are trying to punish Wall Street for mortgage finance practices that expanded home ownership
and spread risk among a host of new players - but also may have duped borrowers and investors who supplied cash to
fuel a housing boom that's turned bust.
A handful of state securities regulators and a couple foreclosure-blighted cities have fired the opening shots with
lawsuits trying to prove that investment banks and big lenders are guilty of more than just bad business decisions and
failing to foresee looming mortgage troubles. Some regulators say greed and fraud underlie much of the subprime
mortgage mess that has spread across the broader housing market, triggering a spike in foreclosures.
Aside from the civil cases, the FBI is looking at possible criminal action, focusing on what Wall Street firms knew
about the risks of mortgage securities backed by subprime loans, and whether they hid risks from investors.
Observers don't expect the financial penalties that regulators extract in the civil cases to be massive. But the cases could
turn up evidence that forces Wall Street to defend itself amid growing talk of government help to ease subprime-related
financial strains on bond insurers. Revelations of bad behaviour turned up by the government also could spur private
investors to file even more lawsuits than the hundreds they've already brought to recover losses.
"This could get a lot nastier, for many reasons," said John Akula, a business law lecturer at the Massachusetts Institute
of Technology's Sloan School of Management. "Prolonged close scrutiny often turns up all kinds of dubious practices
that in normal times are under the radar.
"If the government sponsors any kind of bailout with public funds, this may be coupled with an aggressive
prosecutorial agenda in support of efforts to get private parties to kick in."
Although the foreclosure-blighted cities of Cleveland and Baltimore have sued seeking to recover damages from
mortgage lenders, most of the cases filed so far are from regulators alleging violations of state securities laws.
Attorneys general in New York and Ohio are targeting alleged systematic inflation of home appraisals by major lenders
and appraisal firms. Litigation in Massachusetts and other states seeks to demonstrate that investment banks failed to
disclose risks to investors who bought mortgage-related securities and weren't up front about conflicts of interest across
their far-flung financial operations, including trading of subprime investments.
"Over the years, the relationship between lender and borrower and a particular piece of property has been severed," said
Massachusetts Secretary of State William Galvin. "It's clear that it's become a runaway train."
Gone are the days when most borrowers simply got loans from the neighbourhood bank, which used to hold the bulk of
mortgage risk. Now that risk is spread further - mortgages are bundled together and sold to investors. Behind the
scenes, credit-rating agencies offer advice on whether the investments are secure.
Until recently, cash from Wall Street banks and investors extended growing amounts of credit to low-and middleincome
Americans enticed to enter a market when home prices appeared headed nowhere but up.
Lenders wrote $625 billion in subprime mortgages in 2005, nearly four times the total in 2001. The boom brought in
big fees to mortgage brokers, lenders, banks and ratings agencies.
But now that prices are dropping, those players are hurting. Global banks have ousted executives and have written off
nearly $150 billion since mortgage securities began collapsing last summer.
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Given the losses, "It's doubtful some of these entities will repeat their performance," Galvin said. "But I think there
needs to be an understanding of how we got where we are, whether that is through regulatory action, or through
Congress."
States have responded by tightening rules governing how lenders and brokers arrange mortgages and are compensated.
But lawsuits and administrative complaints are the main tools regulators use to seek fines against companies accused of
wrongdoing, or to set examples to deter bad behaviour.
"What they can't enforce through regulation, they will try to accomplish through suing," said David Bizar, a Hartford,
Conn.-based lawyer with the firm McCarter & English who defends against subprime mortgage lawsuits brought by
consumers and regulators.
Already, the number of subprime-related cases filed in federal courts is outpacing the rate of litigation that emerged
from the savings and loan meltdown in the late 1980s and early '90s, according to a study released Thursday.
The 278 subprime cases filed in federal courts in 2007 already equals half of the total 559 S&L cases handled over
multiple years, according to the findings from Navigant Consulting Inc.
Criminal action also could be looming. The FBI said last month it was investigating 14 companies for possible
accounting fraud, insider trading or other violations that could result in criminal charges. The FBI didn't identify
companies but said the probe involves firms across the financial services industry.
The FBI is working with the U.S. Securities and Exchange Commission, which has civil enforcement powers. The SEC
said in January that it had about three dozen active investigations under way.
In the rush to sue big business, there's plenty of blame to go around in the subprime meltdown, said Bizar, the lawyer
who has represented lenders in subprime cases. Those include everyone from investors buying mortgage-related
investments without understanding the risks, to credit-rating agencies that failed to alert investors to lenders' precarious
positions as mortgage delinquencies spiked.
But the mess can be blamed more on unrealistic expectations than fraud, he said.
"You had a lot of people reaching to get into homes they couldn't afford, on the theory that it would go up in value,"
Bizar said.
© The Canadian Press, 2008
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