Wall Street’s Manhattan Project

The quants from JP Morgan work all over Wall Street now; I was unfortunate enough to run headfirst into one in 2004. His rollout of half a dozen "enhanced index" equity mutual funds has been a flop; perhaps fixed income experts should stay away from the equity markets. But he is not yet taking the heat that a few of his past associates are beginning to feel, although they all seem to have held onto their jobs, no small feat.

Warren Buffett called derivatives financial weapons of mass destruction years ago, but Blythe Masters and the remaining quants at JP Morgan just don't see it that way...

"I do believe CDSs [credit default swaps] have been miscast, much as poor workmen tend to blame their tools."

In 1997, she and a team developed many of the credit derivatives that were intended to remove risk from companies' balance sheets. The idea was to separate the default risk on loans from the loans themselves.

The risk would be moved into an off-balance sheet vehicle. The product was called Bistro, otherwise known as broad index secured trust offering. Guardian

JP Morgan feasted on the fees from the Bistro, but the rest of us are gagging on the lethal stew they created. The days of designing complex products a select few understand might well be over, but the original Masters of the Universe is not apologizing:

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Tougher than Sarah Connor?
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In a guide to understanding the instruments she had created, Masters sung their praises: “In bypassing barriers between different classes, maturities, rating categories, debt seniority levels and so on, credit derivatives are creating enormous opportunities to exploit and profit from associated discontinuities in the pricing of credit risk.”

It was nice, in theory. But from what I have seen the risk was not transferred, given they contributed to the end of investment banking as we know it.

The banks argued that by trading credit derivatives of the kind pioneered by Masters, they had spread their risk elsewhere and therefore needed lower reserves to protect against loan defaults. Regulators rolled over and the banks loaned ever more. It was a huge success and the market for credit derivatives grew rapidly.

You can’t pin it all on her, but one thing is for sure. She could retire comfortably tomorrow if she wanted to.

Sallie Krawcheck and Erin Callan might be toast, but nothing can kill Blythe, who is apparently Wall Street’s version of Sarah Connor.
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The woman who built financial ‘weapon of mass destruction’
Guardian

It Takes Backbone
Working Women

40 Under 40
Crains
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Chris Cox’s statement today on Credit Default Swaps:

There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion notional market in credit default swaps double the amount outstanding in 2006 is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market. This is an area that our Enforcement Division is focused on using our antifraud authority, even though swaps are not defined as securities, because of concerns that CDS offer outsized incentives to market participants to see an issuer referenced in a CDS default or experience another credit event.

Economically, a CDS buyer is tantamount to a short seller of the bond underlying the CDS. Whereas a person who owns a bond profits when its issuer is in a position to repay the bond, a short seller profits when, among other things, the bond goes into default. Importantly, CDS buyers do not have to own the bond or other debt instrument upon which a CDS contract is based. This means CDS buyers can “naked short” the debt of companies without restriction. This potential for unfettered naked shorting and the lack of regulation in this market are cause for great concern. As the Congress considers fundamental reform of the financial system, I urge you to provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets.
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The content contained represent the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No position

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