Amherst’s CDS coup

By Felix Salmon
June 11, 2009

The WSJ’s 1180-word story on “a canny trade by a small brokerage firm in two markets at the heart of the financial crisis” is not easy to follow, but it’s really kinda fabulous.

Basically, a tiny Texas shop called Amherst sold a huge amount of credit protection, at extremely high prices, on a small and obscure bond backed by Californian subprime mortgages. Although the original issue was $335 million, by the time Amherst sold the protection, the amount outstanding was just $29 million: less than 10% of the original amount, and small enough that Amrherst could purchase the remaining loans and pay the bonds off in full.

That wouldn’t normally make sense: the value of the loans was a fraction of the cost of paying off the bonds. But by paying the bonds off in full, Amherst got to keep all the insurance premiums it had been paid by JP Morgan and others, all of whom were speculating on an imminent default. Clever!

JP Morgan and other banks on the losing side of the trade are now whining to Sifma and the American Securitization Forum that it’s not fair they lost money on their speculation that the mortgage bonds would default. Doesn’t your heart just bleed. Well done Amherst: you outwitted the big boys. Good for you.

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