My favorite financial news story of 2013 so far might be the Reuters story last Friday about how NYSE and Nasdaq each listed more IPOs than the other during the first quarter. A normal human might find that odd: listing an IPO is the sort of thing that you tend to notice and keep a record of, so you could pretty easily just add up the IPOs you listed and compare. But to a banker, it’s obvious that everyone would claim, with some sort of semi-plausible justification, to be first in every league table. In fact the explanation is perfectly, almost paradigmatically natural: Nasdaq excludes REITs, spin-offs, and best efforts deals.1 I remember when I used to exclude REITs! Excluding REITs is, like, 20% of what a capital markets banker does.
A deep tension at the heart of the financial industry is that it attracts a lot of quantitative logical evidence-oriented people and then puts them to work in essentially sales roles, and a lot of what it sells is unsubstantiated mumbo-jumbo. You wrote your senior thesis on geometric Brownian motion in the prices of inflation-linked Peruvian bonds from 1954 to 1976? Great, go make a page telling clients why Bank X is so much better at underwriting commoditized debt deals than Bank Y. Or: your thesis took for granted the truth of the efficient markets hypothesis? Great, go market a hedge fund that charges 2 and 20 to beat the market. You have to be quantitative enough to manipulate the data to get it to say what you want (“This fee run is 0.2% higher if we exclude REITs” “Well, do that then”), but not so quantitative that you find the whole process revolting. It’s a hard line to walk, and it’s not surprising that Eric Ben-Artzi or Ajit Jain or the quant truthers at S&P end up disgruntled and either blowing whistles or writing regrettable emails.2
Does that explain Lisa Marie Vioni? I dunno, her economics degree came with a side of French, she became a hedge fund marketer, and she’s done it for over 20 years, so I’d have pegged her as pretty comfortable in the gray areas. But in January 2012 she went to work for Cerberus as an MD selling its RMBS Opportunities Fund, and in February 2013 they fired her, and now she’s suing them. She’s suing in part for gender discrimination, which is hard to evaluate from her complaint but sure, maybe.3
But she’s also suing as a Dodd-Frank whistleblower, because she complained about what she thought were misleading marketing materials and was more or less told to go pound sand. And those accusations go like this: Read more »
Ninety percent of what happens in the typical lawsuit is (1) a lawyer for one side sends a letter to the other side asking for some information to prepare for a trial that will never happen, (2) the lawyer for the other side sends back a passive-aggressive letter refusing to provide that information, and (3) the lawyer for the first side sends a passive-aggressive letter to the judge saying “NO FAIR.” Seriously, that’s what happens. It’s called “discovery,” and it goes on until the lawyers’ bills have gotten big enough that everyone decides to settle the case.
In that milieu, someone sending an aggressive-by-passive-aggressive letter qualifies as huge news, and so there is a lot of excitement over this rather tart mandamus motion that fifteen big banks filed to overturn some discovery rulings that Judge Denise Cote made in a mortgage-backed-securities lawsuit. I will not attempt to convince you that its tartness is all that interesting; I just want you to have context for why some people think it is.
The case is interesting though. The FHFA, the regulator that oversees Fannie and Freddie, is suing the fifteen banks1 for selling crappy subprime residential mortgage-backed securities to Fannie and Freddie. Being a securities-fraud lawsuit, the basic claim is “you lied to us in the offering documents for these RMBS, and we relied on those lies, so we bought your RMBS, and then we lost money because of your lies.” And the lies in the offering documents are not “these mortgages will never default!,” but rather lies to the effect of “we bought these loans from originators, and reviewed those originators’ underwriting practices, and we believe that the originators underwrote them carefully and didn’t just stuff them full of fraud.”
The banks make a pretty good point, though, in this motion: Fannie and Freddie, who were being deceived by the big underwriter banks into buying all these RMBSes stuffed with crappy mortgages from crappy originators, were also separately buying similar mortgages directly from the same originators. And, presumably, doing whatever due diligence they expected the underwriter banks to be doing: Read more »
The Journal had an article this morning about how cash equities traders are getting used to having computers as coworkers but I say unto you: can a computer do this?1
52. On March 31, 2010, Customer A, an investment adviser to a private fund, asked Jefferies to find buyers for several MBS, including Lehman XS Trust Series 2007-15N 2A1 (LXS 2007-15N 2A1) and Harborview Mortgage Loan Trust Mortgage Loan Pass-Through Certificates, Series 2006-10 2A1A (HVMLT 2006-10 2A1A). [Jefferies trader Jesse] Litvak approached a representative at AllianceBernstein about buying the MBS.
53. Litvak told the AllianceBernstein representative that the seller had offered to sell the HVMLT MBS at 58-00 and the LXS MBS at 58-8:
- he will sell to me 20mm orig of hvmlt 0610 @ 58-00 but he is being harder to knock back on the lxs bonds … said that he thinks that one is much cheaper yada yada yada … he told me he would sell them to me at 58-8 (30mm orig) … I would be fine working skinnier on these 2 … but think you are getting good levels on these …
- is he paying u or am I?
- all the levels I put in this room are levels he wants to sell me … I will work for whatever you want on these …. so to recap levels he is offering to me:
hvmlt 06-10 2a1a (20mm orig) @ 58-00
lxs 40mm orig at 58-8…
- Can u wash the hvmlt and [add] 5 ticks to lxs?…
- thats fine.
54. Litvak misrepresented to AllianceBernstein the prices at which Jefferies had acquired the MBS for re-sale. Litvak bought the HVMLT MBS at 57-16 (not the “58-00” he told Alliance Bernstein) and he acquired the LXS MBS at 56-16 (not “58-8” he represented).
55. Litvak also misrepresented the compensation that Jefferies would receive for these trades. AllianceBernstein purchased the $20 million HVMLT MBS at 58 and $40 million of the LXS MBS at 58-13. As a result, on the HVMLT trade, Litvak made 16 ticks for Jefferies; he did not work for free (or “wash” the trade) as he had agreed. And, on the LXS MBS, Litvak made 61 ticks for Jefferies; he did not work for “5 ticks” as agreed.
56. As a result of his misconduct, Litvak made over $600,000 more for Jefferies on the LXS trade and over $50,000 more on the HVMLT trade.
That’s from the SEC’s complaint against former Jefferies trader Jesse Litvak, who apparently made a habit of this sort of thing. He would (allegedly!) tell a potential buyer (seller) of RMBS bonds that he had a seller (buyer), but he would inflate (deflate) the price that he was supposedly getting from the other side in order to inflate his spread. This worked 25 times – that the Feds caught – and allegedly made Jefferies $2.7 million in deceptive profits. This is particularly lovable: Read more »
One thing that would probably be fun would be reading the internal emails sent around at the places that bought terrible RMBS CDOs in the end times of 2006-2007. What did they say? Was it “these mortgages are worth twice what Morgan Stanley is selling them for! We are ripping their faces off”?1 Was it “I looked through a representative sample of the mortgages underlying the collateral in this deal and I think the yield more than justifies the risks”? Was it “my asset-level diligence was light because my macro view is that house prices will go up a lot in the next 18-24 months”? Was it “we have to invest $100mm somewhere and this gets 2bps more yield than other AAA-rated options”? Was it “I don’t know that much about mortgages but I sure am glad we can trust our friends at Morgan Stanley to put us in such a high quality product as this here CDO”? The possibilities are endless and, I think, fascinating: each trade has two sides, and each side has a view, even if that view is sometimes more of a vacant stare.
But the arrow of lawsuits runs only one way so instead we get this:
On March 16, 2007, Morgan Stanley employees working on one of the toxic assets that helped blow up the world economy discussed what to name it. Among the team members’ suggestions: “Subprime Meltdown,” “Hitman,” “Nuclear Holocaust,” “Mike Tyson’s Punchout,” and the simple-yet-direct: “Shitbag.”
The shitbag email chain is part of a collection of internal documents produced in China Development Industrial Bank’s lawsuit against Morgan Stanley over this “Stack 2006-1″ CDO deal that Jesse Eisinger describes today in DealBook and ProPublica. Morgan Stanley has issued the standard “these emails were just a joke and have nothing to do with anything” statement,2 and while normally that is just a meaningless lie that you say after your employees are caught sending around emails saying “this deal is shit, no, I mean it, this deal is composed of actual feces, I am not kidding, come look” – the emails here aren’t that bad. Basically they were like “ugh we gotta name this deal before we print it” and everyone was all “what about Macalester Albermarle Roundtree Paddington Pemberley Structured Finance Limited” and one dope replied with some gallows-humor names. In March 2007. When it was A SUPER DUPER SECRET that subprime mortgages were in trouble:3 Read more »
The SEC settled cases today with JPMorgan and Credit Suisse over “misleading investors in offerings of residential mortgage-backed securities” for a total of about $400 million, which the SEC plans to hand out to those misled investors. There’s been a lot of this sort of thing recently, so here’s a quick cheat sheet on who is suing whom over what mortgages:
- Everyone is suing every bank over all of their mortgages.
So fine but is that not weird? Two things to notice about big banks is that they are (1) big and (2) banks, both attributes that tend to accrue lawyers. And a thing that lawyers are supposed to do is stop stupid cowboy bankers from doing stupid illegal things. If you told me that one or two banks decided to go without lawyers for cost-cutting and/or risk-increasing reasons, I would be skeptical but perhaps willing to play along, but all of them? I am certain that JPMorgan has lawyers.1
The mystery is resolved and/or deepened if you look at most of what is being settled in these cases, which in highly schematic outline was:
- banks wanted to hose investors,
- they asked their lawyers if that was okay,
- the lawyers checked the documents and said “yes,”
- so they did.
In ever so slightly less schematic outline: Read more »
Mortgage-backed securities are sort of conceptually simple – put mortgages in a pot, stir, sell layers of resulting goop – but complex in execution; they have not only economic but also legal and accounting and bankruptcy purposes and so their offering documents are long and boring and filled with dotted and dashed lines and arrows and boxes and originators selling to sponsors selling to depositors selling to trustees selling to underwriters selling to investors. All those arrows serve as a finely calibrated series of one-way gates; each link in that chain is meant to shield the person before the link from something, some real or imaginary claim from the people coming after the link, allowing originators/sponsors/etc. to tell themselves “I never need to worry about those mortgages again!”
Hahahaha no they totally do. Today the Journal and the FT have stories about a possible JPMorgan SEC settlement on some Bear Stearns mortgage practices, specifically (per JPM’s filings) “potential claims against Bear Stearns entities, JPMorgan Chase & Co. and J.P. Morgan Securities LLC relating to settlements of claims against originators involving loans included in a number of Bear Stearns securitizations”. If you’re keeping score these are:
- not the thing where Bear maybe did a shoddy job underwriting mortgages, and
- not the New York state lawsuit involving, besides the shoddy underwriting, Bear Stearns’ settlements of claims against originators, but rather
- the SEC’s investigation of what seem to be those same settlements of claims against originators.1
This is how the FT describes it: Read more »
So, subprime mortgage-backed securities. Here’s a schematic:
- Banks packaged subprime mortgages into bonds and sold them to people.
- The bonds were bad and the people lost money.
What’s the something? There are two main theories. Theory 1 says that everyone knew at some lizard-brain level that it was a bad idea to give lots of money to poor unemployed people with low credit scores to buy overpriced houses, but figured it would work out fine if house prices kept going up. This worked until it didn’t; when house prices went down, badness ensued.
Theory 2 says that, while mortgage originators and securitizers knew that they were giving mortgages to people who had no chance of paying them back, the buyers of those mortgages had no idea: they thought that the originators were holding them to rigorous underwriting standards, where “rigorous” is read to mean “other than requiring a job, or an income, or assets, or a credit score.” When that turned out to be false, badness ensued.
Theory 1 has the benefit of probably being right.1 Theory 2 is superior on every other metric. For one thing, it fits well with deep cultural desires to find villains for the subprime crisis, and punish them. For another, it better fits the explicit facts. No subprime offering document actually said “these guys are all just terrible reprobates and the only way you’ll get your money back is if they can find a greater fool to buy their overpriced house when their rate resets.” But there’s no shortage of internal emails that say – well:
In connection with the Bear Stearns Second Lien Trust 2007-1 (“BSSLT 2007-1”) securitization, for example, one Bear Stearns executive asked whether the securitization was a “going out of business sale” and expressed a desire to “close this dog.” In another internal email, the SACO 2006-8 securitization was referred to as a “SACK OF SHIT”2 and a “shit breather.”
Thanks Eric Schneiderman! Read more »