Thursday, May 26, 2011

Buy-side Responsible for Losses Under the ECB's ABS Data Warehouse

The Market Group informed your humble blogger that his firm was not on the short list to build the ECB's ABS Data Warehouse.  This was not surprising given that the selection criteria were not:
  • Have you built the envisioned ABS data warehouse before (to date, only my firm has); 
  • Are you free of the conflicts of interest that the European Union's Competition Committee finds unacceptable in any firms who have or could control a financial information vendor (my firm is notably free of conflicts of interest);
  • Do you need funds from investors to build the data warehouse (my firm did not);
  • Is the data warehouse you are going to operate going to provide all the useful, relevant information on a current basis for free to all market participants or is it going to charge market participants for access to stale information that guarantees Wall Street retains the equivalent of an insider informational advantage when valuing and trading ABS securities (my firm was going to offer current information for free and eliminate Wall Street's informational advantage)?
Given that these were not the selection criteria, the question the comes to mind is:
What if the ABS Data Warehouse does not restore investor confidence because it is riddled with conflicts of interest from its controlling ownership through its constructor/operator and lacks all the useful, relevant data in an appropriate, timely manner so that an investor could know what they own?
Then the ECB will get to see if it adhered to the advice of Walter Bagehot who said over a century ago that central banks were suppose to lend freely against good collateral.

If the ABS data warehouse fails to restore investor confidence, the ECB will continue to hold almost 500 billion euros of ABS securities of which almost 300 billion euros worth are securities from Greece, Ireland, Portugal and Spain.  The passage of time will show if this collateral is good or not.

Why should the ECB's proposed ABS data warehouse end the buyers' strike?  After all, investors have plenty of investment opportunities other than ABS securities where they do have access for free to all the useful, relevant information in an appropriate, timely manner.

Why invest in securities which have a track record of showing that Wall Street is willing to use its information advantage for its benefit and to the detriment of investors [think shorting sub-prime mortgage backed securities]?

But what if the ECB's ABS data warehouse does end the buyers' strike?  Then, I would have a long and lucrative career as an expert witness.

I would be able to go from case to case where investors lost money on their structured finance investments and testify in their lawsuits against the money managers.  This opportunity would be available because I strongly doubt that any money manager would disclose the following to a perspective investor:
Due to a lack of current information on the underlying collateral performance, investing with me in structured finance securities is asking me to blindly bet on your behalf as there is no way for me to actually know what I am buying or selling.  Without actually knowing what I am buying, I do not know how to tell if the price Wall Street shows represents the bigger fool as a buyer or seller.  Therefore, I cannot make informed investment management decisions.
So long as money managers are investing their clients' money without this disclosure, they are guaranteeing their investors that the investors will not lose money.  How could it be otherwise?

  • The money managers know that the disclosure in the ECB's proposed ABS data warehouse is the same level of disclosure that was not adequate for BNP Paribas to value sub-prime mortgage backed securities in August 2007.  

  • The money managers know that under Article 122a of the European Capital Requirements Directive they have an obligation to know what they own.  No amount of lobbying by the sell-side or regulatory incompetence changes the legislative intent.  The European Commission and European Parliament knew what level of disclosure was inadequate for BNP Paribas and they did not intend to set this level of disclosure as adequate for knowing what you own.
Common sense tells money managers that if the level of disclosure was not adequate for BNP Paribas to value securities, it is not adequate for knowing what they own.

It is simply not a defense to say "well other money managers were buying these securities".  Money managers have a fiduciary duty.

The suggested investment management disclosure by is necessary because without the current data I proposed the ECB's ABS data warehouse should collect and distribute for free, buying an ABS security is just betting on the value of the contents of a brown paper bag.  For any money manager who believes otherwise, I invite them to take the Brown Paper Bag Challenge!

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