Investors Should Spank Banks for Betraying Trust: Mark Gilbert

Mark Gilbert from Bloomberg rocks!

Thanks to Randy Glasbergen

Investors Should Spank Banks for Betraying Trust: Mark Gilbert Nov. 15 (Bloomberg) -- Exactly a year ago, I was summoned to ABN Amro Holding NV's London headquarters for a dressing-down. I had sinned by comparing the bank's glossy new derivatives, dubbed constant proportion debt obligations, to a Nigerian banking scam.

The newfangled securities made bets on credit-default swaps, which are themselves a gamble on company creditworthiness. Steve Lobb, ABN's global head of structured credit, tried to convince me of the error of my skeptical ways with the help of a whiteboard and one of those wonderful diagrams of boxes and arrows showing money flowing from here to there.

This week, Moody's Investors Service said it may cut the Aaa ratings on two of ABN's CPDOs, along with five CPDOs and one swap contract initiated by UBS AG and rated between Aaa and Aa3. Moody's cited ``the continued spread widening and spread volatility on the financial names underlying these CPDOs.''

One of the ABN CPDOs, called Chess III, went on sale in July priced at 100 percent of face value with that golden Aaa rating. This week, it was worth about 41.5 percent of face value, according to ABN prices.

Put another way, the investors who bought the 100 million euros ($147 million) of notes lost 58.5 million euros in just four months. That beats any Nigerian scam.

It turns out that anyone who trusted the CPDO creators -- and even the most sophisticated derivatives buyer has to place some faith in what the stress-testing models of the seller suggest about future valuations -- misplaced their faith.