Friday, August 10, 2007

Mark to market, mark to model

The WSJ reported how the SEC is looking at Investment banks, and the "marks" for their sub-prime loans on their own portfolios. Here's why.

Many hedge funds are being taken out and shot, as these investment banks, that have lent to them, are now asking for more cash for their leveraged positions. Most can recognize, that if the central banks start pumping liquidity into the system, those who are buying here, should do well.

But you need someone to sell, especially at these artificially low prices. So send in the margin clerk, and force some of these players to puke up their positions, as they are marked to the market, not some esoteric model.

Now I'm sure some are complaining about the abuse. I suppose a big client, who did a ton of commission business with these banks would feel he was entitled to some relief.

But that's not how Wall Street works. I can imagine them thinking of all the commission revenue they will miss from hedge fund X, who is closing. So give him a bad mark, take his positions, and make it on a principal transaction, as you buy his marked down merchandise.

But if you mark it down for him, don't you have to mark it down for yourself? That's what the SEC wants to know. Why don't they have losses when everyone else is having them? At least that's probably what the disgruntled fund said to the SEC.

Do you think I'm making this stuff up? Does anyone remember listening to JP Morgan's third quarter conference call last year crowing about the $750 million they made for buying Aramanth's energy portfolio of natural gas positions, when they had "margin calls" and were forced to liquidate? Who was their prime broker that gave Aramanth the margin call that forced the liquidation?

It was JP Morgan, who were able to buy this "distressed" merchandise and sell it two weeks later to Citadel for almost a billion dollars of profit.

So the SEC is on top of this. I'm relieved. The suspense was killing me. But I'll just wait for the investment banks next earnings report.