Thursday, October 20, 2011

ECB's ABS Data Warehouse and Citigroup's CDO related fraud settlement

For everyone who thought that the ECB and its economists would be deterred in their pursuit of the ABS data warehouse, a Bloomberg article confirms they are still pushing ahead.

Not only are they pushing ahead, but
The European Central Bank is considering lending more money against asset-backed securities where issuers provide additional information about the loans securing the bonds, said a person familiar with the matter.... 
The bank’s Eurosystem Risk Management Committee is discussing lowering the reduction on asset-backed bonds from the 16 percent levied now....
The proposed change is part of a broader ECB initiative to encourage banks to improve transparency in asset-backed bonds they sell to investors and boost confidence in a market blamed for worsening the credit crisis in 2007 ....
“The ECB loan-level data project will enhance transparency and standardization on the collateral, so that’s welcome,” said Paolo Binarelli, a fund manager at P&G SGR Alternative Investments SpA in Rome, which oversees 1 billion euros ($1.4 billion) of assets. “The key point is that the cost of disclosing that information mustn’t be too high”...
Hopefully the ECB and its economists have found solutions to the obstacles to the successful implementation of the ABS data warehouse that have been highlighted on this blog.

One of those obstacles, was the timing of the disclosure of the loan-level data for the loans that back the ABS securities.  Leading up to the crisis, this data was disclosed once-per-month after the end of the month.  As originally conceived by the ECB and the Market Group, its chosen agent to implement the ABS data warehouse, this was also the frequency with which the data warehouse would collect and disseminate information.

There is only one small problem with this frequency.  It is not frequent enough so that buyers, including most institutional investors in Europe, of ABS securities under Europe's Capital Requirement Directive 122a can know what they own.

This is not my opinion, but rather the opinion of Moody's and S&P.  Both of these rating agencies told the US Congress in the fall of 2007 that data released with this frequency was inadequate for making timely changes to ratings (a form of valuation).  If you cannot value a security, how can you claim you know what you own?

The SEC has also confirmed that once-per-month after the end of the month is not frequent enough.

The reason I focused on the frequency problem is a NY Times article that reported on Citigroup's settlement of a fraud complaint based on a CDO it sold.  According to the article,
As the housing market began its collapse, Wall Street firms and sophisticated investors searched for ways to profit. Some of them found an easy method: Stuff a portfolio with risky mortgage-related investments, sell it to unsuspecting customers and bet against it. 
Citigroup on Wednesday agreed to pay $285 million to settle a civil complaint by the Securities and Exchange Commission that it had defrauded investors who bought just such a deal. The transaction involved a $1 billion portfolio of mortgage-related investments, many of which were handpicked for the portfolio by Citigroup without telling investors of its role or that it had made bets that the investments would fall in value....
If investors could not value these mortgage-related securities before the crisis because they received information once-per-month after the end of the month, why should they be able to value these securities now with the proposed ABS data warehouse?

The answer is that without addressing the frequency problem, investors cannot do a better job of valuing these securities using the data in the ABS data warehouse.

Since I have written extensively on this problem, I assume that the ECB, its economists and the Market Group have adopted a new disclosure frequency.  Specifically, I assume that the ABS data warehouse will provide performance information on the underlying loans which is current as of the close of business yesterday.  This is the data investors need if they are going to know what they own.

If they have adopted this frequency, this is also very good news for your humble blogger as it suggests that the ABS data warehouse is going to license my patent on an ABS data warehouse which provides current performance information on the underlying loans.

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