Counterparties: ‘More foolish than wicked’ but still self-dealing

July 18, 2012

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The structured and synthetic credit markets just can’t seem to catch a break. Monday was the first day of the civil fraud case against former Citi banker Brian Stoker. The SEC’s case sounds a lot like Goldman’s infamous Abacus deal – Citi sold $1 billion of CDOs to clients without disclosing to investors that it put a $500 million short position on those same securities. Japan’s Mizuho may soon face similar charges.

Stoker’s attorney offered the standard “sophisticated investor” defense, with this additional flourish: “The synthetic CDO market is high-stakes, high-level gambling… However you feel about gambling… this was legal gambling”. As a result, Stoker’s attorney argued, disclosure of conflicts to clients was moot.

As Steven Davidoff writes, the Stoker case threatens to reveal mass incompetence on Wall Street. Instead of your classic stereotype of a greedy trader, Davidoff says the Stoker case reveals something “more banal, merely showing how clueless financiers can be”. The standard sins of conflicted interest, misaligned incentives and an ecosystem of law firms and accountants to condone bad practice will be on display in the trial. Few people, save some hedge funds, thought deeply about the risks: “The likelihood is that this trial will show that many on Wall Street were more foolish than wicked”.

Stoker, a mid-level employee, may fit that bill. Citi, on the other hand, seems to have considered the risks quite specifically and decided to short the deal.

That kind of self-dealing is far from rare. Jesse Eisinger delves into the opacity of the credit default swap markets, where such “high stakes gambling” is the norm. Basic questions, Eisinger writes – like whether Greece’s EU-led bailout constituted a default under CDS documentation – are decided by a “committee [that] operates as a quasi-Star Chamber”. Ten of its 15 members are credit default dealers, and “there’s no prohibition against committee members deciding cases” where they have a financial interest. Eisinger thinks the CDS market is just another case of bad practices becoming “so routine on Wall Street as to almost be unremarkable”. – Ben Walsh

On to today’s links:

Implausible Deniability
HSBC: Banker to drug cartels and Iran – DealBook
HSBC compliance head steps down – FT

New Normal
States’ fiscal crises will last long after the economy recovers – NYT

Peregrine CEO: Sorry, but I spent all the money I embezzled – WSJ

Geithner defends himself against King defending himself against Geithner – Reuters
The Libor scandal “doesn’t illuminate anything very flattering for anyone involved” – All About Alpha

Measuring every inch of the fiscal cliff and its impact on the US economy – WaPo
Democrats propose a plan to sidestep the anti-tax pledge – NYT
Anti-tax crusader Grover Norquist calls Senator Tom Coburn a liar – The Hill

The economic downside of summer: Kids get fatter and dumber – Peter Orzag
How the US fought the summertime unemployment blues during the Depression – Bloomberg

Good News
Why the US labor market is doing a lot better than you think – Conversable Economist

Ups and Downs
Reminder: Historical stock market returns are not the same as one decade’s returns – Business Insider
Bernanke: Do we have a “sustained recovery going on in the labor market, or are we stuck in the mud?” – NYT

Niche Markets
Duane Reade, where cereal is always on sale – The Billfold

Louis Brandeis slams too big to fail…in 1913 – Pedro da Costa

Will the New Yorker “change the Borowitz Report, which is composed entirely of lies?” – Andy Borowitz

Welcome to Adulthood
Cheer up, depressed teens, you’ll make less money later – The Atlantic

“84 Things That Aren’t On an Everything Bagel” and other suggested Buzzfeed listicles – McSweeney’s

In Case You Were Wondering
Lloyd Blankfein likes America. A lot – Politico

Stuff We’re Not Linking To
For Yahoo CEO, two new roles – WSJ


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