Wednesday, October 7, 2009

John Thain: No One Understood CDOs

including himself. Should have said that clearly years ago. This from the Business Insider:

John Thain Admits He Didn't Understand Merrill's Risks
(John Carney, 10/7/09 The Business Insider)

"The bankers and traders dealing in CDOs didn't understand what they were doing, John Thain said in a recent speech.

"“To model correctly one tranche of one CDO took about three hours on one of the fastest computers in the United States. There is no chance that pretty much anybody understood what they were doing with these securities. Creating things that you don’t understand is really not a good idea no matter who owns it,” the former Merrill Lynch chief executive said in a speech this month, according to Financial News."

To be fair, as the writer points out, Thain, former CEO of New York Stock Exchange before he landed on Merrill Lynch, seemed to be clueless to begin with, without saying so explicitly. In his January 2008 conference call, as quoted in the article, Thain said:

It’s very hard to get much more detail to that other than -- unless you actually run the individual positions. The only thing I would say is we believe that we are being conservative on these marks and we think that at the levels that they are marked, we will in fact be able to sell them and/or that they represent value at where they are marked.

Translation: I haven't a clue but I do believe these marks are good enough and we can sell them to equally clueless suckers, umm, buyers.

The Business Insider article concludes:

"We think it's good news that Thain is now emphasizing the knowledge problem when it came to banking--highly paid, well-educated people at the top of their field just didn't understand the credit derivative products they were buying and selling. This is important as much of our financial reform seems to ignore this problem, focusing instead on fixing incentives in compensation."

Good news? They are still buying and selling. Not just that, securitization is back again, assembling legacy CDOs of dubious quality and slapping some form of insurance on the assemblage, and voila, AAA-rated debt security is reborn (read the article about Morgan Stanley's new old effort). So what changed? Not much.

The new buyers - big institutional buyers - (probably they were old buyers, too) must know that they are buying things that they don't quite understand, as Thain says, and that they are risky. But most importantly, they now know there's always a backstop somewhere (the Federal Reserve anyone?), some mechanism to dump their losses on to the least organized stakeholders, i.e. taxpayers who get the privilege to pay for the mistakes but zero chance of participating on the upside.

(Sure, some banks returned TARP money with interest, but was that money refunded to the taxpayers, however small? Noooo.)

"It also undermines the idea that the Fed--or any other regulator--will be able to properly assess the risk of these kinds of derivatives."

They won't be able to. That's why they are fixating on compensation. They cannot even address incentives, because it's their very policy of easy money that distorts incentives. Add the various government backstops ("too big to fail", loan guarantees, etc.) to that, and the government regulators (so called) are just as guilty and complicit as the bankers in creating the mess we're in.

So who DID understand CDOs? Anyone?


Post a Comment