Have to do this quickly as I've been fairly swamped with some work on a paper but this really caught my eye. It's one of those good Dealbook reads (entertaining, exciting and substantive) from Eisinger on the internal memos released because of a suit brought forward in the NY State SC by a Taiwanese bank. Here are some telling highlights of the piece:
"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."
If you think this is an attempt at journalistic humor, think again and go to the hyperlink on "Shitbag". It'll lead you to the actual memo. Yup, not that funny after all. But what exactly is the lawsuit for? I mean, why would a Taiwanese bank want to do this?
It seems like it's because that "Shitbag" stuff was given a legitimate name and packaged off to a Chinese bank. Apparently, a Taiwanese bank bought a piece of the same deal and they didn't find it funny.
"The lawsuit concerns a $500 million collateralized debt obligation called Stack 2006-1, created in the first half of 2006. Collections of mortgage-backed securities, C.D.O.'s were at the heart of the financial crisis."
Anyway, you're bound to run into the whole information asymmetry problem here. Your buyers aren't supposed to be unsuspecting. They may have less information than the seller but isn't that information enough to stay away from "Shitbag"? Shorting is valid, and that's obviously going to be Morgan Stanley's defense.
"The firm is fighting the lawsuit, contending that the buyers were sophisticated clients and could have known what was going on in the subprime market. The C.D.O. documents disclosed, albeit obliquely, that Morgan Stanley might bet against the securities, a strategy known as shorting. The firm did not pick the assets going into the deal (though it was able to veto any assets). And any shorting of the deal was part of a larger array of trades, both long and short. Indeed, Morgan Stanley owned a big piece of Stack, in addition to its short bet."
One bottom line perhaps, is that when they packaged and gift-wrapped "Shitbag" in February 2006, they knew it represented "attractive business".
"Why? In addition to fees, another bullet point listed: "Ability to short up to $325MM of credits into the C.D.O." In other words, Morgan Stanley could — and did — sell assets to the Stack C.D.O., intending to profit if the securities backed by those assets declined. The bank put on a $170 million bet against Stack, even as it was selling it."
So when you revisit the whole defence of an argument that you can't be willingly or maliciously selling a dangerous product if you're holding it and liable for it as well, what it comes down to is (as Eisinger rightly asks) - "Does losing money wipe away sin?"
Read on...
"Why might Morgan Stanley have bet against the deal? Did its traders develop a brilliant thesis by assessing the fundamentals of the housing market through careful analysis of the public data? The documents suggest something more troubling: Bankers found out that the housing market was diseased from their colleagues down the hall.
Bankers were getting information from fellow employees conducting and receiving private assessments of the quality of the mortgages that the bank would purchase to back securities. These reports weren't available to the public. It would be crucial information for trading in securities backed by those kinds of mortgages."
That acts as the counter-argument. Essentially, if it appears that Bank X pawned off a dangerous loaded product to Bank Y or Buyer Y, how much does it matter and more importantly, to what extent does it matter that Bank X held it as well. Where does this paradox get resolved? That you're selling a product you've bet against but you're holding yourself. Or are you?
Eisinger ends with a somewhat more less sophisticated tone that you hear often with respect to subprime discussions but it gets the point across nonetheless. What goes on inside the black box is hard to know because information is blurry, lines are crossed and irrational decisions are made.
"Unfortunately for Morgan Stanley, it had so many other pieces of C.D.O.'s, so many nuclear warheads, that it couldn't find nearly enough suckers around the world to buy them all.
And so when the real collapse came, Morgan Stanley was left with billions of dollars worth of "shitbags".
That hardly seems exculpatory."
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