Monday, February 6, 2012

More CDO-related Mischief: Former Credit Suisse Trader Charged with Falsifying Trading Books

By Olivia Wang, PhD

Last Tuesday we pointed out how Banc of America transferred at least $35 million of previous losses to unsuspecting investors in two of its CDO offerings. This story was further exposed by the New York Times’ reporter Gretchen Morgenson in her report on February 4, 2012 titled “A Wipeout That Didn’t Have to Happen”.

Also in last week, the ex-global head of Credit Suisse Group AG’s CDO business, Kareem Serageldin, was charged in Federal Court by the Manhattan District Attorney for overstating the value of mortgage-related CDOs. On the same day, the SEC filed a Complaint against Mr. Serageldin and three others alleging that they falsely priced the bonds held in their CDO portfolios in order to protect their end-of-year bonuses. This fraudulent behavior led to a write-down of approximately $1.3 billion -- about half of the massive write-downs announced by Credit Suisse’s in March 2008 on asset-backed securities. In total Credit Suisse wrote down $2.65 billion due to “mismarkings” of trading books. One can’t help but wonder: how many other frauds are being perpetrated in CDOs?

After being widely cited as fuel for the housing bubble and for exacerbating the 2008 financial crisis, the new issuances of CDOs dropped significantly. The following graph shows the issuance of new CDOs from 2000 to 2011 compiled (link opens xls file) by Securities Industry and Financial Markets Association.

 Although the amount of new issuance dropped from its peak level of $456 billion in 2006 to just $4 billion in 2009, there was a moderate rebound in new CDO issues in 2011. In 2001 $14 billion of structured finance CDOs (including Residential MBSs, Commercial MBSs, Asset Backed Securities, Credit Default Swaps and other types of securitized products) were issued. The following figure shows the composition of issuance of CDOs in 2011 by the underlying collateral type.

It is still too early to say whether there will be a comeback in the CDO market in the near future, but the continuing litigation involving potential fraudulent behavior in the CDO market definitely teach us one lesson: more oversight will be necessary for CDOs to become trustworthy investment tools.

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