This just in from Bloomberg (the company, not the Mayor). At a conference in Las Vegas, the city where casino gambling is legal and legal prostitution is nearby, Bear Sterns is giving a sales presentation to 50 public employee pension fund managers to convince them to purchase the equity tranches of collateralized debt obligations (CDOs). You can read all about it here: http://www.bloomberg.com/apps/news?pid=20601109&sid=aW5vEJn3LpVw&refer=home. Per Bloomberg “Worldwide sales of CDOs — which are packages of securities backed by bonds, mortgages and other loans — have soared since 2003, reaching $503 billion last year, a fivefold increase in three years. Bankers call the bottom sections of a CDO, the ones most vulnerable to losses from bad debt, the equity tranches. They also refer to them as toxic waste because as more borrowers default on loans, these investments would be the first to take losses. The investments could be wiped out.” A large share of CDOs are backed by subprime and Alt-A mortgage loans. Please someone tell me the NYC and NY State public employee pension funds aren’t buying these.
Some interesting quotes from knowledgable observers to Bloomberg: “I have trouble understanding public pension funds’ delving into equity tranches, unless they know something the market doesn’t know.” “No public fund should invest in equity tranches…fund managers are ignoring their fiduciary responsibilities by placing even 1 percent of pension assets into the riskiest portion of a CDO.” There similarities between Orange County Califonia’s 1994 banrkupcy, “which was the largest municipal bankruptcy in U.S. history, and investments by pension funds in equity tranches.” “Very few pension plans could meet their fiduciary duty by buying portfolios of subprime loans…They spiked up the yield, but that yield means nothing when the defaults start to mount, as we know they will. The funds will take big losses.”
I’ve only learned how these debt securitizations work in the last couple of years. What I’ve wondered is “who owns the toxic waste?” I was told that investors in the “first loss” piece are typically wealthy, sophisticated indivduals that scrutinize every aspect of the deal very carefully, rather than rely on rating agencies which are now claiming it a “misperception” that they offer a rating rather than a non-binding opinion. Sophisticated? “Kay Chippeaux, fixed-income portfolio manager of the New Mexico council, says it decided to buy equity tranches after listening to pitches from Merrill Lynch & Co., Wachovia Corp. and Bear Stearns.” A sophisticated investor would ask why these organizations don’t want toxic waste on their own books.
“Public pension funds have bought more than $500 million in CDO equity tranches in the past five years, according to data from public records requests.” Since the subprime meltdown became apparent, and it’s just starting, it appears that Wall Street is running low on greater fools. So it is turning to the greatest fool of all, the one that likes to promise spending and favors without taxes.