|By GRETCHEN MORGENSON|
TO veterans of
Still, the case against
According to prosecutors in the
Lawyers for both men say that they did nothing wrong and would be exonerated.
But the complaints against both men, laced with e-mails and transcripts of phone calls, indicate that the traders ignored the bank’s protocol for valuing the complex bets and chose instead to mark them in a way that would mask and minimize ballooning losses.
The bets were made on indexes that reflected the performance of a group of corporate debt obligations; the trader in charge of the portfolio had gambled that defaults among these debt issuers would rise. They did not.
It was an outsize bet. By the first quarter of 2012, the so-called synthetic credit portfolio had a total exposure of
The exotic instruments that made up this portfolio did not trade on an exchange and so were harder to value than a stock, whose prices reflect actual market transactions. Because the credit derivatives traded privately, in a so-called dealer market, the traders had to get bids and offers from market participants to value the positions. Bids and offers are not the same as actual transaction prices, of course, but the standard procedure is to assign a value that is somewhere near the middle of the bids and offers.
When the trades went against them, the men deviated from that procedure to cover up some of the losses, prosecutors said.
“None of these trades were done on an exchange or exchangelike platform,” said
Despite Wall Street’s objections, the Dodd-Frank law now requires many of these derivatives to be traded on exchanges or similar platforms. When the rules go into effect in coming months, prices and positions will be more apparent, reducing the possibility and surprise of a whalelike loss.
While the regulations have been written, there are still ways for
ONE of the failures noted by prosecutors in the
The individual designated to police the portfolio valuations looked at them only once a month, for example. And those intermittent reviews relied heavily on the traders for information on the market and price quotations, prosecutors said. The impact: the valuation control group tolerated prices that were outside the bid-offer spreads.
In the aftermath of the mess, officials at
But these institutions and their exposures are so enormous and interconnected that even insiders apply guesswork when assessing exotic positions.
The most illiquid of these holdings, including the kinds of derivatives that wreaked havoc in the chief investment office, fall into a category known in industry parlance as Level 3 assets.
In the valuation hierarchy, Level 1 assets are easy to assess. They include United States Treasury securities and listed stocks. Level 2 is a bit trickier and includes mortgage-backed securities.
Level 3 securities trade infrequently and don’t have readily observable values, allowing bankers the most leeway in their valuations. Since the end of last year,
THE bank and its executives have been deeply embarrassed by the trading fiasco and the internal failures of judgment it exposed. They have learned their lesson, they say.
Investors surely hope so. Because while it is possible to trust these mammoth institutions and what they say their holdings are worth, the verifying remains all too hard.
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|Source:||New York Times Digital|