The money shufflers

The old adage goes that on a Parents Day, a class of children brought their parents in to school. A few parents got up in front of the class to explain what they did for a living. One woman was a firefighter. One man was a baseball player. Another parent was a doctor.

Over in the corner, little Tim was urging his dad to get up and tell the class what he did for a living. But his dad wouldn’t do it. Later, after school, the visibly disappointed boy asked his dad why he wouldn’t get up in front of the class. Was he shy? No. The man told his son, “Tim, you see, I’m an Investment banker. I don’t do anything kids would admire like doctors, firefighters and athletes. I help big companies to raise capital by collecting funds from a group of people called investors who work in other big companies. And I get paid a large fee for facilitating that transaction. “Oh,” said the slightly confused Tim,”you shuffle money.”

I happen to think investment bankers serve a useful function in society, but it isn’t something that is easily explained to a child. Believe me, I know.

I was reminded of this joke when I saw a few stories about repackaging loans to qualify for Fed borrowing. The underlying credits in these deals don’t change, just the package in which it’s sold. It strikes me that these repackage deal are like putting lipstick on a pig. No one is fooled. It’s still a pig. And these are cases where investment bankers truly are money shufflers.

Morgan Stanley, the second-biggest U.S. securities firm by market value, packaged some corporate loans into a new structure that can be swapped for financing from the U.S. Federal Reserve.

About $2 billion of such loans were moved to Ascension Loan Vehicle LLC as of May 31 to make them eligible for Fed financing, New York-based Morgan Stanley said in a regulatory filing. Since May 31, the firm transferred about $460 million of securitized interests in Ascension to Morgan Stanley Darica Funding LLC, according to the filing.

Lehman Brothers Holdings Inc. and JPMorgan Chase & Co. have also repackaged high-risk, hard-to-sell corporate loans into assets that can be pledged as collateral in return for loans from a Fed lending facility, or “window,” set up in March. The securitizations let the firms transfer some of the risk of the assets, called collateralized loan obligations, or CLOs, to the U.S. government on a temporary basis.

“You could make criticisms from the point of view of being a taxpayer, but I think it’s good for Morgan Stanley,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. “The way to make yourself bulletproof is to structure your balance sheet so as much of it as possible is eligible for the discount window.”

Bloomberg News, 10 Jul 2008

Sounds a bit like AAA-rated subprime CDOs if you ask me. And we know how that ended.

The American taxpayer should be concerned when its monetary authority knowingly allows this type of game in order to forestall the inevitable. These loans are impaired and exchanging them for Treasury paper makes no financial sense.

That sound you hear? Oh, that’s the tax money being surreptitiously sucked out of your wallet by the Federal Reserve to help its buddies on Wall Street.

The EU is proposing a better way to deal with this problem. This is something the Fed needs to take on board.

The European Union is considering rules that would force banks to set aside more capital when they sell some of the credit products that were at the heart of the financial crisis, a move designed to rein in practices that led to the current market turmoil.

The rules would affect all banks operating in Europe, including European units of U.S. banks, and make it more expensive to package and sell products like mortgage-backed securities, a process known as securitization.

WSJ, 10 Jul 2008

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