Reply #11: Morgan Stanley Under Criminal Investigation for Using CDOs to Bet Against Clients [View All]

[ozymandius]

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…

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.

More analysis here from Yves Smith.