Commentaries

UBS’ days of wine and CDOs

Expensive wines and toxic assets are rarely mentioned in the same breath.

But that was the talk at UBS during the summer of 2007, when the Swiss banking giant sold some $35 million in soon-to-be rotten collateralized debt obligations to Pursuit Partners, a Connecticut hedge fund, which is now suing the bank.

Last week, a Connecticut judge ruled that Pursuit had presented sufficient evidence that UBS sold the CDOs even though the bank had confidential information that Moody’s Investors Service was planning to slash its credit ratings on those subprime-backed securities.

The judge, in issuing a preliminary ruling against UBS, cited an internal UBS email that has received a fair amount of attention because a trader boasted: “Sold some more crap to Pursuit.”

But it’s the email exchange leading up to that trader’s comment, which wasn’t included in the judge’s decision but was obtained by Reuters, that may be just as revealing.

Much of the discussion between trader Evan Malik and a colleague concerns the amount of money they’d each spent on a 2000 vintage bottle of wine. The sale of the “crap” CDOs almost seems an afterthought in the email thread titled: “95pts Wine Spec. Best Tignanello since 1997.”

On the anniversary of the implosion of Lehman Brothers, it’s important to remember that the financial crisis really began a full year earlier — in July 2007 — with the collapse of two Bear Stearns hedge funds that had loaded up on CDOs.

Wall Street may find itself on the hook

Sometimes legal fishing expeditions pay off.

A year ago, a Connecticut hedge fund sued UBS, contending that it knowingly sold toxic mortgage-backed securities to institutional investors but never disclosed that information.

At the time, the accusation by the fund, Pursuit Partners, seemed intriguing. But because the complaint lacked any sign that it had the beef to back up its potentially explosive claim, the litigation all but fell off the radar screen.

Now, it appears the hedge fund managers were onto something, thanks to a Connecticut state judge’s decision to allow Pursuit’s lawyers to get limited access to some of UBS’ internal emails.

In some of the emails, the investment firm’s employees describe the $35 million in collateralized debt obligations sold to Pursuit in summer 2007 as “crap” and “vomit.”

At first glance, it might be easy to chalk this up as simply another case of Wall Street bankers peddling securities they privately thought were junk.

But the big revelation unearthed by Pursuit’s lawyers is the extent to which credit rating agency Moody’s Investors Service shared information with UBS about its impending decision to lower its ratings on some of the CDOs the firm was selling.

from Neil Unmack:

Finance’s 80s experiment shows cracks

We may never see mullet hairstyles or other weird fashions again, but in finance, there is a 1980s revival.     The International Accounting Standards Board has gone back to the future, allowing banks to reclassify assets they previously had to mark to market as loans and receivables, valued at amortized cost. That effectively allowed them to avoid the embarrassment of mark-to-market and return to the historic cost accounting of a quarter-century ago.     The reasons are plausible enough: many asset classes were quoted at nominal, distressed sale prices only. But you ignore market prices at your peril: problems loans are left to fester, exposing investors to the cost of loan managers (understandably) taking a rosy view of advances they may have approved.     Many European banks took advantage of the IASB's lenience to whip doubtful assets off their trading books -- not just plain debt, but collateralized loan obligations, leveraged loans and other doubtful exotica. Now Deutsche Bank <DBKGn.DE> has indicated how this stuff is doing, and the answer is: badly.     Deutsche's pretty figures would have been quite spoiled had it taken a further 1.4 billion euros of unrealized losses on the 37 billion euros of assets it reclassified since last October.     The discrepancy between the carrying value and fair value shouldn't be a surprise -- that was the whole point of the changes. Unfortunately, the market is proving to have been right in pricing some of these assets as junk, because the losses in the reclassified book are starting to show.     More than half of Deutsche's 1 billion euro provisions for credit losses in the second quarter derived from these reclassified assets. Some 2 billion euros of the 3.2 billion euro rise in problem loans had previously been reclassified.     Deutsche is not alone. RBS' <RBS.L> impairment losses on reclassified assets rose to 747 million pounds in the first three months of the year, up from 466 million at the end of last year. UBS is carrying assets reclassified last year at 24.7 billion Swiss francs, versus the fair value of 20.6 billion.     The accounting changes are not designed to bamboozle investors, even though that is frequently the result. Losses may have been deferred, but they will happen. The question for banks is whether they can generate profits quickly enough to offset them. Market prices that seemed ridiculous in the depths of the panic may turn out not to have been the equivalent of the mullet after all.

Repaying TARP….not so fast

The Obama administration is on the verge of letting a number of financial institutions–think Goldman Sachs and JPMorgan Chase–to begin paying back tens of billions in bailout money. That may sound like a good idea, especially with the federal deficit continuing to balloon. But what’s the rush?

It’s obvious why the banks want to get out from under the Troubled Asset Relief Program: they want to be free of government meddling and prove they can operate without government support. But Sandy Lewis and William Cohan, in a long op-ed in The New York Times on Sunday, make a good case for the administration going slow in allowing banks to repay the bailout money.

I particularly like their suggestion that bank executives be forced to testify under oath about the causes of the financial crisis before any institution can repay TARP money. It brings to mind that infamous hearing when Congress hauled the CEOs of the tobacco companies to Capitol Hill and forced them to testify under oath about whether or not cigarettes caused cancer. Let’s force the bank executives to testify then whether they really believed a bundle of subprime mortgages could be turned into a Triple A security by waving some credit-agency pixie dust over it. Or whether it made sense to operate their firms with leverage ratios of 30 to 1.

Lewis and Cohan also rightly argue that the banking system is far from fixed. The recent surge in the stock market and a slight slowdown in the pace of job losses should not lull anyone into believing that the economy is on the fast road to repair. If all the talk about economic green shoots is just some mirage, the banks could be in for a lot more trouble if there’s a new spike in mortgage defaults or corporate bankruptcies. And given the current public mood, it will be impossible to provide any struggling bank with a new round of financial aid.

So why not wait a few more quarters, to make sure that the first quarter’s relatively strong bank results are sustainable. There’s a lot of reason to believe those results won’t be repeated in the second and third quarters. A good deal of the strong numbers posted by the banks came from trading gains fueled by bnormally big spreads between the yields on Treasuries and corporate bonds. Banks also got the benefit of a last minute accounting gift from FASB, which made it easier to value some hard-to-value assets.

Another thing the Obama administration should do is force the banks to rid themselves of some of the toxic assets clogging their balance sheets before they can repay any TARP money. Why not force the banks to take-up an idea I suggested last week, which would permit banks to donate ailing CDOs and other rotting securities to charitable trusts. That way, the banks could get a tax write-off to offset some of their losses and cash-starved charities would get these asssets for free. If CDOs and other ailing assets ever recover in value, the charities would be looking at some instant cash.

The truth is, until the banks get rid of the bad debts on their balance they never really will be healthy again.