From Mark Mitchell at Deep Capture:
If short sellers can manipulate the price of credit default swaps, they can disrupt those companies whose debt is insured by the credit default swaps whose prices are manipulated. The game plan runs as follows: find a company that relies on a layer of debt that is both permanent, and which rolls over frequently (most financial firms fit this description). Short sell that company’s stock. Then manipulate the price of the CDS upwards, preferably into a spike, as you spread the news of the skyrocketing CDS price (perhaps with the cooperation of compliant journalists at, say, CNBC).
Because the CDS is, in essence, an insurance policy on the debt of the company, the spiking CDS pricing will cause the company’s lenders to panic and cut off access to credit. As this happens, the company’s stock will nosedive, thereby cutting off access to equity capital. Thus suddenly deprived of credit and equity, the firm collapses, and the hedge fund collects on its short bets.
Moreover, credit default swap prices are the primary inputs for important indices (such as the CMBX and the ABX) measuring the movement of the overall market for commercial and home mortgages. In the months leading up to the financial crisis of 2008, short sellers pointed to these indices in order to argue that investment banks – most notably Bear Stearns and Lehman Brothers – had overvalued the mortgage debt and property on their books. Meanwhile, several hedge funds made billions in profits betting that those indexes would drop.
It should therefore be a matter of some concern that credit default swap “prices” and the indexes derived from them are determined almost entirely by a little company with zero transparency and, it appears probable, a high exposure to influence from market manipulators. The company is called Markit Group, and there is every reason to believe that its CDS-driven indices (the CMBX, the ABX, and several others) are inaccurate, while the credit default swap “prices” that they publish and which rock the market are in fact nowhere close to the prices at which credit default swaps actually trade…
Markit Group’s founders also include four hedge funds. However, Markit Group refuses to disclose the names of those hedge funds…
Goldman Sachs, JP Morgan and several other investment banks also have ownership stakes in Markit Group…
Assuming that those four hedge funds and the 22 “contributors” (or hedge funds affiliated with them) bet against public companies, it seems more than possible that short-sellers got to run the craps table, call the dice, and place bets, all at the same time.
So perhaps it is not surprising that a lot of long-shot rolls paid off quite nicely.
A commenter wonders if The Greatest Trade Ever is a coincidence:
In a span of just three years, hedge-fund manager John Paulson went from practically unknown to practically unparalleled. After a series of smart bets against the housing market made Paulson’s hedge fund billions of dollars—including days where it made more than $1 billion—he earned a place alongside George Soros and Warren Buffett as an oracle of investing. In his new book, The Greatest Trade Ever, Gregory Zuckerman, a reporter at The Wall Street Journal, examines how the unlikely team of Paulson and assistant Paolo Pellegrini—as well as a few other investors—bucked conventional wisdom and saw through the housing hype.
Another commenter links to more context:
Paulson asked his investment banks to create new issues of repackaged subprime mortgage securities, known as collateralized debt obligations, or CDOs, so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs’ subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities, which had been ignored by the rating agencies, Paulson could collect up to $5 billion.
Here’s the tie in to Markit Group:
Prior to 2006, there were not many opportunities for naked short selling on subprime securitizations. But in January of that year, investment banks launched a new product, which enabled Paulson to place those bets on a large scale. The ABX index, a sort of Dow Jones Average of subprime mortgage securities, facilitated benchmarking the price of credit default swaps. But it appears that Paulson made much more money by betting against the newly issued CDOs.
And why Bear Stearns had to die:
Among the banks that Paulson had approached, Bear Stearns saw the deal for the sham that it was, and refused to play along. Trader Scott Eichel said that, “it didn’t pass the ethics standards; it was a reputation issue, and it didn’t pass our moral compass. We didn’t think we could sell deals that someone was shorting on the other side.”
On the death of Lehman Bros.:
the head of Lehman’s commitment committee was an executive named Allan Kaplan, who had been with the firm for more than 30 years and was known as “the conscience of Lehman.”…
Kaplan died in 2003, and afterwards, there were fewer restraints on Fuld’s bullying style for pushing deals through. Coincidentally, subprime securitizations took off in a big way the next year.
Yet another commenter links to Blankfein’s crocodile tears:
Goldman announced yesterday that it is putting $500m aside to help 10,000 small US businesses. The donation (equal to 3% of its bonus pot) will be managed by a council led by Blankfein, Harvard Business School professor Michael Porter, and legendary investor Warren Buffett.
Blankfein also admitted he regretted telling the Sunday Times that Goldman was simply doing “God’s work”, adding that he meant the comment as a joke.
And another commenter links to charges of muni bond derivative bid rigging in California:
Bank of America Corp., UBS AG and JPMorgan Chase & Co. were sued by a California public utility over claims they rigged sales of municipal derivatives and shared illegal profits through kickbacks.
The lawsuit, filed by the Sacramento Municipal Utility District, is based on federal and state antitrust claims. It alleges Charlotte, North Carolina-based Bank of America and more than a dozen other banks conspired to pre-select winners of municipal derivative auctions, coordinated their pricing, and accepted kickbacks disguised as fees from co-conspirators.
Still another commenter points to Alan Greenspan’s complicity while Chair of the Fed:
Mr. Greenspan joined the payroll of the hedge fund, Paulson & Company, which last year made $15 billion in profits betting that poor people’s homes would be foreclosed on while using the unregulated over-the-counter contracts that Mr. Greenspan assisted in making possible.
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