Rob Peebles: The CDO flying circus


By Rob Peebles
Saturday, June 30, 2007

"Merrill Lynch & Co. on Wednesday sold only $100 million of $850 million of highly rated collateral assets it auctioned after seizing them back from the Bear Stearns funds, said a person familiar with the auction. Details about Merrill's auction and efforts by Bear Stearns to offer $2 billion of CDOs were not immediately clear as possible buyers determine how to value the complex CDOs. Some fund managers speculated the failure to sell the assets as intended indicated the dealers were largely disappointed with what they saw."

-- Reuters, June 21, 2007

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"Lehman and Credit Suisse held auctions of this collateral before the bailout, and insiders claimed the former sold the assets for half their face value, a development with huge consequences for Wall Street and the stability of the global financial system if true. The pricing is crucial because US financial regulations require banks and hedge funds to value CDOs on their books at market price, but, because of the illiquid nature of the instruments, they usually retain them at the purchase price. ... If Lehman achieved such a low price for the CDOs, it could precipitate a major revaluation of the sector that may, domino-like, devastate related markets. Last week, Merrill Lynch attempted to auction CDOs worth $850m; some traders claim it managed to sell about $100m. No prices were revealed."

-- "A bet that went wrong," Helen Dunne, The Business, June 30, 2007.

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"'... A lot of hedge funds are now trembling -- and I don't mean because Congress wants to raise the tax rate on general partners' carried interest. The big hedge fund secret is that, barring credit downgrades, many leveraged and esoteric investments (such as the collateralized debt obligations that inhabited the Bear Stearns hedge fund) aren't marked to market.'"

-- "Hedge funds' dirty little secret," Doug Kass,, June 28, 2007.

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Thanks to lots of discretion in all the right places, the Bear Stearns hedge fund blow up has yet to trigger a financial debacle worthy of a Shakespearean tragedy. With lenders to Bear Stearns' hedge funds pacified, if not satisfied, and CDO values still under wraps, the event unfolded more like a Monty Python skit:

Banker: Excuse me!

Farmer: Yes, sir? Me, sir?

Banker: Yes, quite. I believe my bank loaned you money some time ago to buy a pig. That loan is now due. When can we expect payment?

Farmer: Oh, I can't pay you, sir.

Banker: I'm sorry, I've had a cold. Can you repeat that?

Farmer: Yes, I said I can't pay you.

Banker: Still can't hear you. Annoying things, these colds.

Farmer (shouting): I said I can't pay you back the money, sir. Hard times, you know.

Banker: Can't pay back the money? Oh, dear. What will my supervisor say?

Farmer: That's why I'm going to the market, sir. To sell the pig. And then give your bank the money.

Banker: What pig?

Farmer: This pig, sir.

Banker: Oh, that is a pig you have there. So you sell the pig and then you give me the money? I see. Splendid. Are you sure? It looks sick.

Farmer: Sick? Why, it's the healthiest pig there is, sir.

Banker: But look at its face! It's got a rash or something.

Farmer: That's not a rash. It's lipstick.

Banker: Lipstick on a pig?

Farmer: It's pretty, isn't it"

Banker: Well, yes, sort of. I mean no! No, it's not pretty. It's ridiculous.

Farmer: Watch what you're saying. You might offend her.

Banker: Well, why would a pig be wearing lipstick?

Farmer: Because without the lipstick it would be just a pig. Now it's a pig with lipstick. She's worth a lot, you know.
Banker: How much will you get
for her, then? Enough to pay back the loan?

Farmer: With lipstick and all?

Banker: Yes, yes, how much?

Farmer: I don't know. A lot, I suppose. You know, pigs like this are in demand.

Banker: In demand? Since when did so people have such an interest in buying pigs with makeup on them?

Farmer: Oh, these pigs have been quite the thing for a while now. And it's just lipstick, sir. No eye shadow or anything.

Banker: So when will you have money?

Farmer: After the auction. It's right in here, sir.

...At the auction...

Farmer: It's our turn now, sir. See, there's my pig. The one with the lipstick.

Banker: They've ALL got lipstick!

Farmer: I told you it was the thing, sir.

Auctioneer: Now, what do I hear for this pig, pig No. 236?

Farmer (shouting): Don't forget the lipstick!

Auctioneer: What do I hear for pig No. 236 wearing lipstick? Do I hear 100? One hundred?

Farmer (to banker): See, that's just what I owe you, 100.

Auctioneer: How about 90? Do I hear 90? How about 80?

Banker: There's no one bidding!

Auctioneer: Seventy-five, 75? Sixty?

Farmer (shouting): That's top-of-the-line lipstick!

Auctioneer: How about we start the bidding at 50? Anyone bid 50? Fifty?

Banker (jumping up): Hold it, we've changed our mind!

Auctioneer: Changed your mind?

Banker: Yes, we've changed our mind. We're not selling. The pig is off the market!

Farmer: Why is she off the market? I thought you wanted the money.

Banker: Money is not everything. We're leaving.

Farmer: Don't you want to see what my neighbor's pig sells for?

Banker: Who is your neighbor? Oh, him? I loaned money him money too. Tell him to come with us. Let's forget this whole pig-selling thing. As far as our bank is concerned, your pigs are still worth 100. We don't need an auction to tell us that.

Farmer: What about the money we owe?

Banker: Oh, you still owe it. But let's not worry about that right now.

Farmer: You look like you could use a stop by the pub, sir.

Banker: Grand idea. Let's get out of this wretched place.

Farmer: You think I can bring my pig inside? She likes pinball.

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