The Online Merriam-Webster Dictionary describes alchemy as “a power or process of transforming something common into something special” or “aiming to achieve the transmutation of the base metals into gold.” Well, it seems Morgan Stanley is engaging in some financial alchemy because it is about to trade near-junk rated paper for Aaa gold-standard bonds (hat tip Max Keiser and Stacy Herbert).
Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings in the first transaction of its kind, said two people familiar with the sale.
Morgan Stanley is selling $87.1 million of securities that it expects to receive top AAA ratings and $42.9 million of notes graded Baa2, the second-lowest investment grade by Moody’s Investors Service, according to marketing documents obtained by Bloomberg News. The bonds were created from Greywolf CLO I Ltd., a CDO arranged in January 2007 by Goldman Sachs Group Inc. and managed by Greywolf Capital Management LP, an investment firm based in Purchase, New York.
Here’s the problem. In June, Moody’s downgraded the Aaa tranche of this CDO six notches to A3 because the default rate for loans in the tranche soared to 7 percent. So, now, Morgan Stanley has been able to re-package this paper, and…voila this debt is Aaa again. Everybody’s doing this repackaging. Goldman plans to sell over $200 million of repackaged Commercial mortgage-backed paper very soon.
So, when earnings start coming in this quarter and you are wondering how these banks aren’t writing down huge losses due to events like this and this, you now have one more reason why. Here are two more reasons here and here. The question is whether investors will be fooled.
ps. – I am sure Morgan Stanley added credit enhancement, collateral, reduced the poorly performing assets, etc, etc. But, nevertheless, you have to wonder how this stuff gets a Aaa rating when substantially the same loan pool was just downgraded six notches.