THE BANKS MADE ME DO IT!

3/25/10

In today’s (i.e., Thursday, 3/25/10’s) Wall Street Journal, on page A5, we learn that Depfa Bank, PLC, which is based in Dublin (Ireland, not Ohio) and is a unit of Hypo Real Estate Holding, AG, which is based in Germany, has seized $5.5 million left in trust to backstop losses suffered by five Wisconsin school districts that invested $35 million in, as the paper calls them, “exotic securities.” The districts will probably lose the $35mm and could be on the hook for another $150mm. Ouch. The districts are suing Stifel Financial, which advised the districts, and Royal Bank of Canada, which sold the investments. Ah, the wonders of the globalization of the financial markets! But that is another issue.

It is difficult to determine from the article what it is these school district purchased. First, the securities are described as “subprime related securities,” which might lead one to believe that the districts bought a tranche of a collateralized mortgage obligation (“CMO”). Later, the article says the districts purchased “bundles of corporate debt RBC packaged into collateralized debt obligations,” which would lead one to believe that the districts bought an intermediate to lower tranche of a corporate CDO. Later, the article reports that “School officials believed they were investing directly in a portfolio of corporate bonds, rather than insuring against corporate defaults,” which would lead one to believe that the districts were selling credit default swaps (i.e., were short the protection). Finally, the article states that the “borrowers included Fannie Mae, Freddie Mac, and other companies that were hit hard as the financial crisis worsened.” This might clear it up; the school districts may have purchased a tranche, and probably a lower tranche, of a CDO that was comprised largely of debt of mortgage originating or guaranteeing corporations like Fannie and Freddie. From this article, though, one can’t be sure exactly what the districts bought.

Though I can’t tell what the districts bought from this article, I would surely make it my business to understand what it was I was buying if I were the purchaser. This, of course, is a point of distinction between me and the school districts. As the Journal reports:

The Wisconsin school districts claim they bought investments they didn’t understand or were misled by banks and securities firms.

It is certainly not beyond the realm of possibilities that the districts were misled by the various financial “experts” with whom they were consorting. But when one buys securities one doesn’t understand, and relies on those selling those securities to explain them, how does one blame anybody but one’s self, and maintain a straight face, when thing don’t work out as one’s salesperson (Oh, I’m sorry…financial advisor) predicted? As I have said before in a similar context, this is very much akin to blaming the train for the consequences when one lies down on the tracks.