Counterparties: ‘More foolish than wicked’ but still self-dealing
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The structured andÂ syntheticÂ 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 â€“ 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 faceÂ similar charges.
Stoker’s attorney offered the standard “sophisticated investor” defense, with this additional flourish:Â ”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 â€“ like whether Greece’s EU-led bailout constituted a default under CDS documentation â€“ are decided by a “committee [that] operates as a quasi-Star Chamber”. Ten of its 15 members are credit default dealers, and “thereâ€™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”. â€“ Ben Walsh
On to today’s links:
Geithner defends himself against King defending himself against Geithner â€“Â Reuters
The Libor scandal “doesnâ€™t illuminate anything very flattering for anyone involved” â€“Â All About Alpha
Measuring every inch of the fiscal cliff and its impact on the US economy â€“Â WaPo
Democrats propose a plan to sidestep the anti-tax pledge â€“Â NYT
Anti-tax crusader Grover Norquist calls Senator Tom Coburn a liar â€“ The Hill
Ups and Downs
Reminder: Historical stock market returns are not the same as one decade’s returns â€“Â Business Insider
Bernanke: Do we have a â€œsustained recovery going on in the labor market, or are we stuck in the mud?” â€“Â NYT
Stuff We’re Not Linking To
For Yahoo CEO, two new roles â€“ WSJ