Friday, Dec 21, 2007

Enron was a mild spat in kindergarten compared to this trainwreck

Financial Crookery: The Bond Insurance Barge Scam

Spot the difference:

(A) In 1999 Enron effects a transaction through an SPV allowing it to get a [Nigerian power-generating barge] off its books allegedly in order to improve its reported numbers for the period. Later the trade has to unwind and the barge must be brought back on the books rendering Enron exposed to its real (somewhat less impressive) value all the time.

(B) In 1999-2007 investment banks effect transactions with SIVs allowing them to get a [lot of credit clag(1)] off the books allegedly in order to improve reported numbers for the period. In 2007 under adverse liquidity conditions [the SIVs with the worst liquidity constraints] fold and the credit clag must be brought back on the books rendering the banks exposed to its real value all the time

Posted by lvmreader @ 01:40 AM (1007 views) Add Comment

3 Comments

1. lvmreader said...

ACA is downgraded to CCC. Negative watch for a pile of others. Good timely stuff from the rating agencies. Thanks chaps. CalculatedRisk quotes a portfolio manager at American Century Investments:

Its a zero-sum game. If you put trades on that worked so well that you bankrupt your counterparty, you will not collect on those trades.

Succinct enough. The NY Times chips in with the story on the inevitable bailout by those owning the ACA insurance. Put another way, if I owe my lender $3,000, it's my problem. If I owe him $3,000,000,000 it's his problem.

Can anyone spot the difference in the following:

(A) In 1999 Enron effects a transaction through an SPV allowing it to get a [Nigerian power-generating barge] off its books allegedly in order to improve its reported numbers for the period. Later the trade has to unwind and the barge must be brought back on the books rendering Enron exposed to its real (somewhat less impressive) value all the time.

(B) In 1999-2007 investment banks effect transactions with SIVs allowing them to get a [lot of credit clag(1)] off the books allegedly in order to improve reported numbers for the period. In 2007 under adverse liquidity conditions [the SIVs with the worst liquidity constraints] fold and the credit clag must be brought back on the books rendering the banks exposed to its real value all the time.

(C) From 1999-2007 investment banks effect transactions with bond insurers allowing them to get a [lot of credit clag] off the books allegedly in order to improve reported numbers for the period. In 2007 under adverse market conditions the [insurer with the worst net exposures] goes bust, the insurance is worthless and the credit clag must be brought back on the books rendering the banks exposed to its real value all the time.


Plus ca change. Here's the one which hasn't happened yet:

(D) From about 2000-2008 many investment banks purchase credit default protection from each other allowing them to get [a lot of credit clag] off the books allegedly in order to improve reported numbers for the period. In 2008 under adverse default conditions the [bank with the worst net exposures] goes bust, its sold protection is worthless and....well, just make up your own forecast of how this pans out. It can't be pretty.

No new news here, I suppose. Yet there's no amount of ISDAs, Credit Support Annexes, netting arrangements or other protection which will help anyone if it occurs. For years the investment banks' internal credit and risk departments have been outwitted by smarter, better paid front office mobsters. These "business prevention officers/BPOs" may have wrested some control back in the last 6 months, but the credit default firework is primed and the fuse is burning faster than they can move. If we are lucky, the firework might not explode when the fuse reaches it, but that will be down only to chance.

Friday, December 21, 2007 02:10AM Report Comment
 

2. alan said...

Thanks for finding and making these posts. It is much easier to understand the situation through these simple examples.

Friday, December 21, 2007 09:28AM Report Comment
 

3. Alex S Gabor said...

What the hell is a "credit clag"?? He seems to be the only one using it in the English Language.

Monday, December 24, 2007 03:43AM Report Comment
 

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