ONE MORE QUESTION
TO ASK IN DISCOVERY: WHAT ENTITIES WERE CREATED OR EMPLOYED IN THE
TRADING OF MORTGAGE BONDS, CDO’S, SYNTHETIC CDO’S OR TOTAL RETURN SWAPS (NEW TERM)?
EDITOR’S COMMENT: LOUISE STORY, in her article in the New
York Times continues to dig deeper into the games played by Wall Street
firms. You’ll remember that the executives of the major Wall Street
firms were spouting off the message that the risks and consequences were
unknown to them. They didn’t know anything was wrong. Maybe they were
stupid or distracted. And maybe they were just plain lying. The risks to
these fine gentlemen and their companies are now enormous. If the veil
of non-disclosure (opaque, in Wall Street jargon) continues to be
eroded, they move closer and closer to root changes in Wall Street and
both criminal and civil liability. It also leads inevitably to the
conclusion that the loans and the bonds were bogus.
Yes it is true that money exchanged hands — but not in any of
the ways that most people imagine and not in any way that was disclosed
as required by TILA, state law, Securities Laws and other applicable
statutes, rules and regulations. They continue to pursue foreclosure
principally for the purpose of distracting everyone from the truth —
that the transactions were wrong in every conceivable way and they knew
If there was nothing wrong with these innovative financial
products why were they “off-balance sheet.” If there isn’t any problem
with them now, then why can’t they produce an accounting, like any other
situation, and say “this person borrowed money and didn’t pay it back.
We will lose money if they don’t — here is the proof.” If everything was
proper and appropriate, then why are we seeing revealed new entities
and new layers of deception as Ms. Story and other reporters dig deeper
The answer is simple: they were hiding the truth in circular
transactions that were partially off balance sheet and partially on. I
wonder how many borrowers would be charged with fraud for doing that?
Now, thanks to Louise Story, we have some new names to research — Pyxis,
Steers, Parcs, and unnamed “customer trades. They all amount to the
The bonds and the loans claimed to be attached to the bonds
were being bought and sold in and out of the investment banking firm
that created them. If they produce the real accounting the depth and
scope of their fraud will become obvious to everyone, including the
Judges that say we won’t give a borrower a free house. What these Judges
are doing is ignoring the reality that they are giving a free house and
a free ride to companies with no interest in the transaction. And they
are directly contributing to a title mess that will take decades to
untangle.August 9, 2010
Merrill’s Risk Disclosure Dodges Are Unearthed
By LOUISE STORY
It was named after a faint constellation in the southern sky: Pyxis, the Mariner’s Compass. But it helped to steer the mighty Merrill Lynch toward disaster.
Barely visible to any but a few inside Merrill, Pyxis was created at
the height of the mortgage mania as a sink for subprime securities.
Intended for one purpose and operated off the books, this entity and
others like it at Merrill helped the bank obscure the outsize risks it
The Pyxis story is about who knew what and when on Wall Street — and
who did not. Publicly, banks vastly underestimated their exposure to
the dangerous mortgage investments they were creating. Privately,
trading executives often knew far more about the perils than they let
Only after the housing bubble began to deflate did Merrill and other
banks begin to clearly divulge the many billions of dollars of troubled
securities that were linked to them, often through opaque vehicles
In the third quarter of 2007, for instance, Merrill reported that its
potential exposure to certain subprime investments was $15.2 billion.
Three months later, it said that exposure was actually $46 billion.
At the time, Merrill said it had initially excluded the difference
because it thought it had protected itself with various hedges.
But many of those hedges later failed, and Merrill, the brokerage
giant that brought Wall Street to Main Street, soon collapsed into the
arms of Bank of America.
“It’s like the parable of the blind man and the elephant: you had
some people feeling the trunk and some the legs, and there was nobody
putting it all together,” Gary Witt, a former managing director at Moody’s Investors Service who now teaches at Temple University, said of the situation at Merrill and other banks.
Wall Street has come a long way since the dark days of 2008, when the
near collapse of American finance heralded the end of flush times for
many people. But even now, two years on, regulators are still trying to
piece together how so much went so wrong on Wall Street.
The Securities and Exchange Commission
is investigating whether banks adequately disclosed their financial
risks during the boom and subsequent bust. The question has taken on new
urgency now that Citigroup has agreed to pay $75 million to settle S.E.C. claims that it misled investors about its exposure to collateralized debt obligations, or C.D.O.’s.
As Merrill did with vehicles like Pyxis, Citigroup shifted much of
the risks associated with its C.D.O.’s off its books, only to have
those risks boomerang. Jessica Oppenheim, a spokeswoman for Bank of
America, declined to comment.
Such financial tactics, and the S.E.C.’s inquiry into banks’
disclosures, raise thorny questions for policy makers. The investigation
throws an uncomfortable spotlight on the vast network of hedge funds
and “special purpose vehicles” that financial companies still use to
finance their operations and the investments they create.
The recent overhaul of financial regulation
did little to address this shadow banking system. Nor does it address
whether banking executives should be required to disclose more about the
risks their banks take.
Most Wall Street firms disclosed little about their mortgage holdings
before the crisis, in part because many executives thought the
investments were safe. But in some cases, executives failed to grasp the
potential dangers partly because the risks were obscured, even to
them, via off-balance-sheet programs.
Executives’ decisions about what to disclose may have been clouded by hopes that the market would recover, analysts said.
“There was probably some misplaced optimism that it would work out,”
said John McDonald, a banking analyst with Sanford C. Bernstein &
Company. “But in a time of high uncertainty, maybe the disclosure burden
should be pushed towards greater disclosure.”
The Pyxis episode begins in 2006, when the overheated and overleveraged housing market was beginning its painful decline.
During the bubble years, many Wall Street banks built a lucrative
business packaging home mortgages into bonds and other investments. But
few players were bigger than Merrill Lynch, which became a leader in
Initially, Merrill often relied on credit insurance from the American International Group
to make certain parts of its C.D.O.’s attractive to investors. But when
A.I.G. stopped writing those policies in early 2006 because of
concerns over the housing market, Merrill ended up holding on to more
of those pieces itself.
So that summer, Merrill Lynch created a group of three traders to
reduce its exposure to the fast-sinking mortgage market. According to
three former employees with direct knowledge of this group, the traders
first tried sell the vestigial C.D.O. investments. If that did not
work, they tried to find a foreign bank to finance their own purchase
of the C.D.O.’s. If that failed, they turned to Pyxis or similar
programs, called Steers and Parcs, as well as to custom trades.
These programs generally issued short-term I.O.U.’s to investors and
then used that money to buy various assets, including the leftover
But there was a catch. In forming Pyxis and the other programs,
Merrill guaranteed the notes they issued by agreeing to take back any
securities put in the programs that turned out to be of poor quality.
In other words, these vehicles were essentially buying pieces of
C.D.O.’s from Merrill using the proceeds of notes guaranteed by Merrill
and leaving Merrill on the hook for any losses.
To further complicate the matter, Merrill traders sometimes used the
cash inside new C.D.O.’s to buy the Pyxis notes, meaning that the
C.D.O.’s were investing in Pyxis, even as Pyxis was investing in
“It was circular, yes, but it was all ultimately tied to Merrill,”
said a former Merrill employee, who asked to remain anonymous so as not
to jeopardize ongoing business with Merrill.
To provide the guarantee that made all of this work, Merrill entered into a derivatives
contract known as a total return swap, obliging it to cover any losses
at Pyxis. Citigroup used similar arrangements that the S.E.C. now says
should have been disclosed to shareholders in the summer of 2007.
One difficulty for the S.E.C. and other investigators is determining
exactly when banks should have disclosed more about their mortgage
holdings. Banks are required to disclose only what they expect their
exposure to be. If they believe they are fully hedged, they can even
report that they have no exposure at all. Being wrong is no crime.
Moreover, banks can lump all sorts of trades together in their
financial statements and are not required to disclose the full face
value of many derivatives, including the type of guarantees that
“Should they have told us all of their subprime mortgage exposure?”
said Jeffery Harte, an analyst with Sandler O’Neill. “Nobody knew that
was going to be such a huge problem. The next step is they would be
giving us their entire trading book.”
Still, Mr. Harte and other analysts said they were surprised in 2007
by Merrill’s escalating exposure and its initial decision not to
disclose the full extent of its mortgage holdings. Greater disclosure
about Merrill’s mortgage holdings and programs like Pyxis might have
raised red flags to senior executives and shareholders, who could have
demanded that Merrill stop producing the risky securities that later
brought the firm down.
Former Merrill employees said it would have been virtually impossible
for Merrill to continue to carry out so many C.D.O. deals in 2006
without the likes of Pyxis. Those lucrative deals helped fatten profits
in the short term — and hence the annual bonuses paid to its employees.
In 2006, even as the seeds of its undoing were being planted, Merrill Lynch paid out more than $5 billion in bonuses.
It was not until the autumn of 2007 that Pyxis and its brethren set off alarm bells outside Merrill. C.D.O. specialists at Moody’s
pieced together the role of Pyxis and warned Moody’s analysts who rated
Merrill’s debt. Merrill soon preannounced a quarterly loss, and
Moody’s downgraded the firm’s credit rating. By late 2007, Merrill had
added pages of detailed disclosures to its earnings releases.
It was too late. The risks inside Merrill, virtually invisible a year
earlier, had already mortally wounded one of Wall Street’s proudest
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Filed under: CASES, CDO, CORRUPTION, GTC | Honor, HERS, Investor, Mortgage, Motions, Pleading, bubble, evidence, expert witness, foreclosure, foreclosure mill, foreign relations, inflation, investment banking, trustee | Tagged: Custom trades, HERS, Louise Story, Ny Times, Parcs, TOTAL RETURN SWAPS