SEC Continues to Pick Through CDO Bones

Yesterday’s Financial Times carried an article related to the latest news surrounding the US Securities and Exchange Commission’s probe of CDO structures that were completed at the height of the market’s period of insanity leading up to the credit market crash in 2007.

The story line seems to be similar to the investigation of Goldman Sachs and its ABACUS structure that was brought to market in 2007.  The general storyline was that Goldman intentionally structured the transaction, which utilized late vintage sub-prime mortgages for collateral, to fail.  Now word comes that the SEC is investigating a Merrill Lynch structure that was structured on behalf of a hedge fund client, Magnetar.  The CDO, known as Norma was managed by a new York-based firm called NIR Capital Management.  One holder of the securities, Rabobank had sued Merrill (BoA) in 2009 alleging that the arranger intentionally overvalued many of the loans in the collateral pool.

These investigations are not only complex in content but the whole notion of trying to recreate individual motivations and the timing of those motivations is difficult at best.  Add the particularly volatile conditions in the markets in 2007 and we are sure that good arguments will be made on both sides of these transactions as to what actually went down.

One truth that can often be forgotten in these “Monday morning quarterback” scenarios is that most of these firms were not in the business of completing one or even a few bad deals and then running for the hills like Jesse James.  Most CDO managers and deal arrangers were in the business of building reputable franchises and would not have survived to do another deal, if the trade was bad enough, given the high levels of competition in the CDO market at the time.

We’re not suggesting that there couldn’t have been bad deals done by folks with bad intentions.  We would just hope that people recognize that there are likely just as many sharp investors realizing that a litigation strategy might be a way to fix some bad trading decisions made at a time when we were all so smart.

About markferraris
Managing Principal Orchard Street Partners LLC

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