Tonight, we have breaking news from the Wall Street Journal telling us that Morgan Stanley is on the business end of a (what Yves Smith over at Naked Capitalism is referencing as "criminal") fraud probe by the Securities and Exchange Commission (SEC) concerning collateralized debt obligations (CDO's) which Wall Street traders nicknamed the "dead presidents" deals, due to the fact that the CDO's were named after 19th Century U.S. presidents, including Andrew Jackson and James Buchanan.
Apparently, according to the WSJ story, Morgan Stanley "...helped design the deals and bet against them, but didn't market them to clients." They left that task to Citigroup and Swiss banking giant UBS.
NOTE #1: The word, "criminal," has been in quotes in the headline since I originally posted this a few moments ago. I thought it made it apparent that I was aware that the filing of any "criminal" charges would be brought forth by entities that were authorized to do same, such as the DoJ. (I've discussed this reality in numerous previous posts about other firms currently in the crosshairs of the SEC and the DoJ.) I find it interesting that folks in this community--at least in the first few comments on this diary--have opted to focus upon that as opposed to the gist of the story. So, please consider this "note" a clarification of the matter.
This just appeared on Naked Capitalism over the past 10 minutes...
NOTE #2: Diarist has received written authorization from Naked Capitalism Publisher Yves Smith to reproduce diaries that appear on her blog in their entirety here on DKos.
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Morgan Stanley Under Criminal Investigation for Using CDOs to Bet Against Clients
Naked Capitalism
Yves Smith
Tuesday, May 11, 2010 12:31AM EST
The Wall Street Journal reports that Morgan Stanley is under investigation for allegedly creating CDOs it used to wager against clients:
Among the deals that have been scrutinized are two named after U.S. Presidents James Buchanan and Andrew Jackson, a person familiar with the matter says. Morgan Stanley helped design the deals and bet against them, but didn't market them to clients. Traders called them the "Dead Presidents" deals....
Among the Morgan Stanley deals that have been scrutinized are the Jackson and Buchanan CDOs, created in mid-2006. Those deals essentially were portfolios of derivatives that aped the performance of dozens of residential and commercial mortgage-backed securities. Morgan Stanley helped to create the deals, which each issued about $200 million in bonds and were underwritten and marketed to investors by Citigroup Inc. and UBS AG, respectively....
One feature of the Morgan Stanley deals was a structure that could increase the magnitude of the bullish investors' exposures to the underlying mortgage bonds. This feature, which was disclosed in some offering documents, made it more likely that such investors could lose money if the underlying bonds performed poorly.
Morgan Stanley traders took the more profitable, bearish side of these transactions, according to traders. These positions weren't disclosed in some deals. It couldn't be determined how much money Morgan Stanley made with these wagers...
There have been several rounds of SEC subpoenas issued in the probe, a person familiar with the matter says. Last summer, the SEC asked Wall Street firms about any of their clients that were betting against CDOs, the person says. In the fall, Morgan Stanley provided offering documents to the SEC about CDOs, including its Dead Presidents deals. Morgan Stanley, among other firms, received a subpoena in December 2009 asking about its sale and marketing of CDOs, people familiar with the matter say.
Yves here. To give an idea how difficult it is to investigate bad practices in the CDO market, we had been told about the dead President deals (and a similar program by Citigroup) but were not able to find the offering documents through our normal research avenues. It is likely going to take continued investigation by prosecutors and lawsuits from private parties to unearth a good bit of what happened in this market.
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