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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If the JPMs get a bit of time to think this through, I think they’ll realize they don’t want to contest this. Unless they’re stupider than I think.

If this proves evidential of their best move, then 2nd best was hiring Laurie Goodman (formerly at UBS) as mortgage strategist. One of the best minds around when it came to MBS.

Partying in Austin, no doubt

Posted by Griff | Report as abusive

Amherst is hardly a tiny shop…big player in MBS, and as noted, hired Laurie Goodman who has basically been one of the top mortgage analysts on wall street for a while…but yeah, kick ass trade!

Posted by am | Report as abusive

also – the CDS on ABS contract is “pay as you go” as there is no concept of an imminent default for an MBS bond. Also desks have routinely shown lists of bonds with potential for clean up calls. Its assumed that if protection was sold 3 years ago and now the seller clean up calls the deal(cause they also own the bonds) then its ok but if the seller of protection soon after buys the bond to exert this option, thats pretty straight up market manipulation.

interesting debate indeed but the firms should have probably known that this was not outside the realm of possibility for such a low balance deal

I have a pretty good idea why Laurie may have thought of that trade. She actually got her clients to buy something like she sold to JPM and others (from what I’ve heard it was her “trade” idea). I wonder if she learned from her mistake, but I seriously doubt it was her who came up with that.

Posted by anonymous | Report as abusive

I’m confused how this trade works. To make a profit, it seems to me that you would have to sell more protection than there are bonds, no?

Sandrew: Yes. That’s quite common in the CDS market.

Posted by Felix Salmon | Report as abusive

Someone in the know please explain – why would the client banks buy protection if premium costs exceed the value of the bonds? It may have been cost-effective for Amherst to buy the reduced-value bonds directly, but what happened to the ($335M original – $29M final) value? Who got turned on the $306M? Was this much of the original $335 paid off by homeowners (seems unlikely …)?

Posted by JohnJay60 | Report as abusive

thanks for the article. much more informative than the wsj article.

Posted by edwin | Report as abusive

johnjay – great questions. i suspect that the banks did little or no homework. also, how many more of these amhearst deals are out there?

Posted by edwin | Report as abusive

So the big boys are crying over getting beat at their own game. Amherst did nothing wrong. People need to realize that swaps are not investments, they are bets – this is gambling. Except the difference here is that the bookies are typically amateurs, and the game can be legally rigged. I’m surprised that nobody thought of this before. It’s like The Sting, profiting on the greed and stupidity of the buyers.

Posted by KenG | Report as abusive

Hi Felix,
sorry to be picky but is it possible to put up on future articles whether or not they are behind a paywall? maybe just a simple (paywall) comment after the article. It’s annoying reading about this article and wanting to read it only to find it’s behind a paywall.

Posted by Duff Samoa | Report as abusive

Try…just as likely to have a version of the same story

Posted by Griff | Report as abusive