Wall Street Banks Blindsided Gambling with Monies Entrusted to Them

Jun 16, 2009 | Updated May 25, 2011

Please be patient; this is as complicated as it is outrageous. Complicated because that's the way Wall Street and the Financial Community wants it to be, so that they can run rings around us while we don't know what's going on until we are presented with the tab, and then never quite understand what the tab is for.

Well for once, the key pushers of these murky instruments got their comeuppance. Reported in the Wall Street Journal in the opaque jargon of the brotherhood: "The trade involved credit default swaps and securities backed by subprime mortgages with risky credit profiles. The original securities had been issued by Lehman Brothers and were backed by $335 million of subprime mortgages." It seems bets had been made on the performance of some $27 million of these securities.

Being passingly creative, let's assume these $27 million in securities are bonds in circulation backed by the good faith and credit of the Confederacy. Let's designate them as "Confederate Bonds." Those institutions and/or individuals holding these bonds are rightfully anxious and prudent to insure against their seemingly inevitable default by buying "credit default swaps"(CDS's). Given the clearly evident risk, the insurance premium is high (the price of the CDS's) -- 80-90 cents on the dollar

But here's the rub. If something looks like a good bet you can buy CDS's to your heart's content. And if you're a bank, why not? It is not altogether your money but rather that of your depositors, much of which is insured by the government's Federal Deposit Insurance Corporation, or convenient TARP monies, or myriad other government-funded programs. And of course should the trade blow up to the point of putting your institution at risk there is always Joe Taxpayer to pull you out of a hole. Thus, on the $27 million of the "Confederate Bonds" in play, some $130 million credit default swaps were created and issued and gobbled up by those valiant bankers at Bank of America, JP Morgan, and on.

But the story gets better. To pick up those $130 CDS's on the "Confederate Bonds" you need someone to issue the CDS's. And here we have our financial cavalry, our Texas Rangers riding over them thar' hills far from Wall Street in the guise of Austin Texas' Amherst Holdings. First Amherst bought up many of those "Confederate Bonds" at deep, deep discounts. Then accommodating the big boys on Wall Street created and sold much of those CDS's insuring against the risk of default on the original $27 million "Confederate Bonds" in play and well beyond (remember the total issuance of CDS's against the original $27 million securities ballooned to $130 million) for which the Wall Street honchos were expecting a bonanza by the complete wipeout of the "Confederate Bonds," thus enabling them to collect their CDS insurance at 100 cents on the dollar.

Well, the boys out of Austin had a better idea. They made arrangements to pay off the "Confederate Bonds" out of their own resources, thereby crashing the value of the credit default swaps to zero. Good for those who held the "Confederate Bonds." But a complete wipeout for those CDS holders who were recklessly gambling on a complete default without any vested interest to hedge against other than a straight-out gamble. The boys from Texas, as sellers of CDS's to the Wall Street contingent, did exceedingly well, pocketing the premiums they collected for much of the monies bet on CDS's beyond the $27 million in actual play.

According to the WSJ article, firms that suffered losses brought the trade to the attention of financial industry groups such as the Securities Industry and Financial Markets Association and the American Securitization Forum. Representatives of JP Morgan, Goldman Sachs, among others, held a conference call to discuss the trade but didn't come to any conclusions. The banks' losses were reported in the tens of millions. Probably what was not discussed was why banks feel that after the current financial debacle that rote gambles such as these should be tolerated by a public that has been called upon to pull their chestnuts out of the fire time and again. It becomes morbidly clear why our financial markets and institutions have gone to hell in a hand basket.

As for the guys and gals from Austin, should they be visiting New York, they should know there are some excellent restaurants that now seem to have tables available that were previously unavailable to us mere mortals. And if you let me know where and when, I'd be most happy to send over a bottle of champagne!