Yet another way to loose money on a CDS

http://www.econbrows...w_to_lose_on.html

There was a wonderful story in today's WSJ about how some big banks managed to lose some of their hard-earned TARP money.

Unfortunately you have to subscribe to the WSJ to get the whole story, but it's not that hard to follow. A small company called Amherst Holdings sold CDSs on some obviously toxic California mortgages. They then paid the company holding the mortgages to make good, insuring they wouldn't have to pay the CDSs and pocketed the difference.

This is causing some steam in Wall Street, since Amherst Holdings suckered some of the biggest finance firms in the country into wasting their money. The only sad part of this is that a good part of the money lost was TARP money, so they where wasting US tax payer money.

Breaking it down, Amherst sold CDS on a bond backed by subprime California Mortgages. Originally worth $335 million, but now priced at $29 million, which is important for reasons that will become clear in a moment. Even at $29 million it was obviously overpriced and set to default.

Wall Street firms saw a chance for some easy money, take out a CDS on the bond and wait for it to fail. The CDSs where very expensive, since the underlying bond was obviously likely to fail and the Wall Street Brokers probably should have been suspicious when they found anybody willing to sell. But Amherst sold $130 million in CDSs to various firms, at a price of around $110 million.

Amherst had no intention of paying off on that insurance however. Instead, they took advantage of a special rule designed to help companies clear out left over bits rather then have to carry them forever. If the mortgages left in the fund are less then 10% of the original value of the mortgages, they company holding them can pay off the bond in cash and close it out. The rule is designed for to handle situations when most of the home owners have paid off their mortgages and there are too few left in the fund to make it worthwhile. But the rule says nothing about why the value of the mortgages has gone done.

So Amherst paid the company holding the mortgages the $29 million to make good on the bond. I believe Amherst ended up with the underlying mortgages also, but that isn't clear. And those mortgages are not worth much anyway. The point is that Amherst collected $110 million in CDSs fees and paid $29 million to make good. So Amherst go a quick profit of around $80 million.

And boy are some people on Wall Street ticked off about it.

Jay

Post #309,599 by jay 6/12/09 10:01:35 AM Reply	Yet another way to loose money on a CDS http://www.econbrows...w_to_lose_on.html There was a wonderful story in today's WSJ about how some big banks managed to lose some of their hard-earned TARP money. Unfortunately you have to subscribe to the WSJ to get the whole story, but it's not that hard to follow. A small company called Amherst Holdings sold CDSs on some obviously toxic California mortgages. They then paid the company holding the mortgages to make good, insuring they wouldn't have to pay the CDSs and pocketed the difference. This is causing some steam in Wall Street, since Amherst Holdings suckered some of the biggest finance firms in the country into wasting their money. The only sad part of this is that a good part of the money lost was TARP money, so they where wasting US tax payer money. Breaking it down, Amherst sold CDS on a bond backed by subprime California Mortgages. Originally worth $335 million, but now priced at $29 million, which is important for reasons that will become clear in a moment. Even at $29 million it was obviously overpriced and set to default. Wall Street firms saw a chance for some easy money, take out a CDS on the bond and wait for it to fail. The CDSs where very expensive, since the underlying bond was obviously likely to fail and the Wall Street Brokers probably should have been suspicious when they found anybody willing to sell. But Amherst sold $130 million in CDSs to various firms, at a price of around $110 million. Amherst had no intention of paying off on that insurance however. Instead, they took advantage of a special rule designed to help companies clear out left over bits rather then have to carry them forever. If the mortgages left in the fund are less then 10% of the original value of the mortgages, they company holding them can pay off the bond in cash and close it out. The rule is designed for to handle situations when most of the home owners have paid off their mortgages and there are too few left in the fund to make it worthwhile. But the rule says nothing about why the value of the mortgages has gone done. So Amherst paid the company holding the mortgages the $29 million to make good on the bond. I believe Amherst ended up with the underlying mortgages also, but that isn't clear. And those mortgages are not worth much anyway. The point is that Amherst collected $110 million in CDSs fees and paid $29 million to make good. So Amherst go a quick profit of around $80 million. And boy are some people on Wall Street ticked off about it. Jay
Post #309,601 by boxley 6/12/09 10:08:55 AM Reply	some people on wall street are fsking stupid
Post #309,602 by drook 6/12/09 10:10:00 AM Reply	"And boy are some people on Wall Street ticked off about it" Is that so? Well, let me clear my throat here so I can be crystal clear. [a-hem] *BOO-FUCKING-HOO!* You mean someone took advantage of the letter of the law, manipulating things in a way clearly contrary to the intent, benefiting because their marks relied on things to work the way they always had? Hey now, sucks being on the other side of that for a change, doesn't it? -- Drew
Post #309,653 by static 6/13/09 9:58:06 PM Reply	The letter of the law instead of the spirit of the law. You can't legislate against cunning... Wade. "Ah -- I take it the doorbell doesn't work?"

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