UBS asked Paramax Capital International to sell it protection on $1.3bn of the most highly rated slices of a CDO made up of subprime residential mortgages that the UBS investment bank underwrote. In general, by hedging the risk fully through the credit derivatives market, banks can remove such exposures from their balance sheets and do not have to set aside capital...
Paramax claims that, from the beginning, the UBS hedge was cosmetic. In May 2007, when the original agreement was signed, the terms were a fraction of the market rate. Why agree to such thin terms? You put yourself at risk, no? Also, Paramax had only $200m under management and its agreements with its own investors limited it to commit no more than $40m to any single deal. Thus, it could never compensate UBS fully for any meaningful loss in value of the $1.3bn UBS was trying to insure, it claims. So, Paramax must be in the monoline insurance biz
. I know, that was a low blow...
Paramax also claims that UBS told it that the bank would employ “subjective valuation methodologies” that meant it would not record any loss in value that could trigger calls for additional margin from Paramax... You set yourself up for this one fellas! Paramax also claims that UBS promised that if the lender needed a “real” hedge, it would tear up the agreement... I can't wait for this to be defined in court and made precedent. Let's repeat that again, " A "real" hedge"! I'll paraphase a huge part of the article for you. The market turned to shit, and the banks started to pretent that they had "real hedges" in place.
Now UBS is taking Paramax to court, seeking to compel it to pay up as the securities drop in value, alleging breach of contract. Paramax in turn is charging UBS with negligent misrepresentation. UBS said the bank was confident in the merits of its case. A lawyer for Paramax said its allegations were supported by both written and oral statements. The combination of subjective valuation and hedges that may not be real because counterparties cannot or will not pay goes way beyond UBS and Paramax. Oh boy, does it. Monolines, investment banks, commericial and mortgage banks, homebuilders mortage finance arms, leasing and consumer finance companies. I can really go on. Remember these posts, ya'll:
- I know who's holding the $119 billion dollar bag!
- Banks, Brokers, & Bullsh1+ part 1
- Banks, Brokers, & Bullsh1+ part 2
Remember, these CDS were used as hedges, and often support other positions. For instance, I buy a CDO, hedge it with Paramax (instead of a "real hedge"), then take the freed up (should have been reserved) capital from the hedge and do another nonsense leveraged deal with it using less than optimal capital because it was "hedged"with a Credit Default Sucker" (sorry about that, I meant swap). I then keep going on until I have maxed out my leverage, which is only indicated at 20 to 35x on my 10Q, but the actual leverage is much more when you consider my use of Credit Default Suckers! Again, reference Banks, Brokers, & Bullsh1+ part 2 for how quickly this can build up.
For example, in one case the seller of credit protection discovered that the final agreement on insuring a portfolio of collateralised debt obligations had never been signed, either by it or a French bank which in this case was buying protection. Now, with the meltdown in that market, the seller has returned all the premium payments to the buyer and torn up the agreement, saying that because it was never signed, it has no legal obligation to pay up...
No need to fret, Paulson and a bevvy - I mean a plethora - of financial CEOs state that the worst is behind us... If you want to see leverage, risk and overvaluation - that is actually lauded and applauded by both the press and Wall Street, stay tuned for my next post on the Golden Boys...
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