There’s an alternative theory of the 2007-2008 financial crisis in which it was just a minor hiccup that would have worked out fine for all concerned if the meddling U.S. government hadn’t been so trigger-happy in bailing out basically sound but momentarily embarrassed financial institutions.1 I mean, you probably won’t actually run into anyone who believes this theory, because it is a pretty loony theory. And yet! It keeps coming up in court, which I guess means the courts are full of loonies, QED.
Obviously Hank Greenberg is the most vocal and delightful proponent of this theory, since he’s been suing the government for ever and ever for taking over AIG when AIG actually would have been just fine with a little eleven-digit low-interest loan from the government. But Fannie Mae and Freddie Mac shareholders have come on strong of late, with weird lobbying for re-privatization of their shares and, now, a lawsuit filed yesterday seeking $41 billion in damages over their bailout.
The theory here should be familiar if you’ve been following along with AIG; it goes something like this: Read more »
Fundamentally if you’re a sell-side M&A banker your job is to find a buyer and get them to overpay for the company you’re selling. I mean, oh, you know, you’re a repeat player and reputational concerns and continued business relationships and all that militate against getting them to overpay too much. But mostly, the more they overpay the better you’ve served your client. Also, though, those reputational things etc., plus lots of fraud laws, militate against getting buyers to overpay by deceiving them about stuff relating to the company you’re selling. You can’t, like, just go forge financial statements. That’s cheating, and not in an admiring hahaha-you-got-me way. In a jail way.
So what’s left? One thing you can do is gently deceive them about the competitive dynamic. This might seem a little silly – if you’re buying a company, shouldn’t you be carefully determining its fundamental value rather than just bidding a penny more than whoever else is in the auction? – but in fact a lot of the M&A function is pretty much exactly that. You set up an auction, you demand confidentiality, you forbid bidders from talking to each other, you don’t tell them each others’ bids, you don’t announce to the world when a bidder has dropped out, all with the goal of creating the appearance of more competition than there is. When the bidders share too much information about their bidding plans with each other, you sue them. If a possibly viable but spivvy bidder comes along, you encourage them to stick around and throw out big numbers, just to keep the other bidders on their toes. “Yes, Carl Icahn, please, tell us more about your plans to buy our company,” is a sentence you might find yourself saying. You don’t outright lie, but you do your best to create the impression that your particular fertilizer-byproducts company is the prettiest girl at the dance or whatever the going metaphor is.
Here’s a fun Libor lawsuit: the ghost of problematic former hedge fund FrontPoint is suing the Libor banks for (1) selling FrontPoint some interest-rate swaps and (2) manipulating Libor in a way that hosed FrontPoint on those swaps. Here is the complaint and here is Alison Frankel on the legal issues, which are interesting and which we can talk about a little below.1
Up here let’s talk about the trades that FrontPoint (and Salix Capital, which now owns these claims) is suing over. They’re interest rate swaps, of course, where FrontPoint received Libor, and where Libor was systematically manipulated lower by banks looking to enhance confidence in themselves by showing lower funding costs. But those swaps were part of a larger negative-basis package trade where (1) FrontPoint bought bonds (funded at a spread to Fed Funds), (2) FrontPoint bought CDS from a bank to hedge credit, and (3) FrontPoint entered into a swap with the bank to hedge interest rates. Schematically, when everything cancels, it looks like this:
Everyone knows the story of Abacus 2007-AC1 by now: Goldman Sachs sold some mortgage-backed-security CDOs to some people, and those people thought that the underlying mortgage-backed securities were chosen by an outfit called ACA Management to be Good, but in fact they were chosen by Paulson & Co. to be Bad, and they turned out to be Bad, and that was Bad. The SEC sued Goldman over it, and Goldman settled for $550 million, and then everyone else sued too because they had been lied to about who picked the mortgage-backed securities (Paulson, not ACA) and why (to fail, not to succeed).
Among the people who sued was ACA, whose role in the transaction was (1) pretending to pick the underlying RMBS and (2) issuing a financial guaranty policy (to Goldman) referencing the super senior tranche of Abacus. That tranche more or less went poof, and ACA ended up owing $840 million to Goldman (though, really, ABN Amro paid the $840mm, and Paulson got it).1 Since ACA was in the business of writing terrible financial guaranty policies, it blew right up and ended up paying only $30 million. Then it sued Goldman for the $30 million back, plus punitive damages. ACA’s claim is that, while it knew that Paulson had selected the underlying RMBS, it thought Paulson was net long Abacus, because Goldman schemed and lied, and that it wouldn’t have insured Abacus if it’d known the truth about Paulson’s position.
Yesterday ACA lost when a New York appellate court dismissed its case. The court split 3-2, and the opinion is short and pretty weird; basically the majority says “it doesn’t matter that Goldman lied to ACA about Paulson’s position, because ACA should have kept asking until it got the truth,” which is a funny law.2 The two dissenting judges seem to have rather the better of it.3
One possible reaction to Apple’s gigantic tax-optimized share repurchase program is to think that spending a lot of time fiddling with how to optimize your share repurchase program mightmean you’re out of better ideas. You can ponder whether this Intel share repurchase trade described in a Lehman Brothers bankruptcy lawsuit filed yesterday supplies any evidence on that question. Intel decided to buy back $1bn of its stock in August and September of 2008, and rather than just buy it in the market it entered into a pretty fiddly forward contract with Lehman like so:1
Intel gives Lehman $1bn on August 29.
Lehman hands the $1bn back to Intel for safekeeping – it’s Lehman’s money, but Intel keeps it as collateral.
On September 29, Lehman gives Intel some shares, based on the average price of Intel stock from August 29 to September 26.2
The dollar amount of shares Intel buys is $1bn, if the average price is $21 or below, or $250mm, if the average price is $25 or above, or some amount linearly in between if the average price is between $21 and $25:
If the dollar amount Intel buys is less than $1 billion, Lehman gives back the extra money.
So in other words as the stock price goes up Intel buys fewer shares, and vice versa, which is kind of wrong-way for them3 but right-way for Lehman.
In exchange for that risk Lehman agrees to give them a discount of 10.6 cents per share.4
The number of shares Intel buys is equal to the dollar amount divided by the average price minus 10.6 cents:
Standard & Poor’s asked a federal judge on Monday to dismiss a U.S. Justice Department civil suit against the rating agency, arguing the government’s case is based on vague statements that cannot be used to prove fraud. In a $5 billion suit, the U.S. government accused the rating agency of issuing inflated ratings on faulty products to drum up business before the financial crisis, despite company statements that its ratings were objective. S&P has vociferously defended itself in public since the case was filed in February in U.S. District Court in Los Angeles, denouncing the lawsuit as meritless and accusing the government of cherry-picking emails to misconstrue what its analysts did…While the government says those messages, which include one analyst performing a pop song parody about the housing market burning down, paint a picture of a company knowingly slapping inflated ratings on structured finance products, the company’s filing says otherwise. Those messages, instead, the company said, show internal squabbling or even “robust internal debate.” [Reuters]
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