A reader wrote to tell me his firm had been shown transactions at the end of 2007 from an investment bank (not Lehman) that he was confident were to tart up its balance sheet. This confirms the hardly shocking idea that window dressing was not limited to Lehman:
Around Dec 2007 bank I work for was approached by XXX to transact a total return swap transaction. The underlying for the TRS would be a large portfolio of ABSes (and CDO tranches – name your toxic stuff, it was there). The deal was offered as “You do TRS with us, we sell you the portfolio and at the end of the deal we buy the portfolio back, no risk, hey?”. It was very clear to me that this was a balance-sheet dressing exercise, as they were very keen to do the transaction before their reporting date.
When I pointed it to our legal dept., they said that since they are doing legal thing, it’s all OK. In the end we turned the transaction down anyway (and, in line with my suspicions about the reason once the reporting date passed they enthusiasm for the transaction evaporated).
Our salesperson could not understand that this was a credit product on XXX, and that just because transaction like this might have priced at 10bp over Libor two years ago, with XXX CDS spreads in their hundreds pricing it at 30bp was NOT a good price.
In general, some credit intermediation trades that some of the large players tried to suck other banks into were unbelievable.
It was also really interesting from the incentives perspective – sometimes it was clear that the transaction people were trying to shove around in the market was a potential time-bomb, but sales people still wanted to do it as the processes they had to follow, and criteria for their performance were by then obsolete and easily gameable.
For example some of the counterparties were still ranked as good/excellent credit risk in the systems, even though they were on the verge of going under, so computed return on equity on the transaction was all of sudden huge, and the computed risk small. Of course, the reality was quite opposite, but when was the last time a reality check stopped a determined sales person? And if the counterparty got downgraded afterwards, they could still say “yeah, but when I did the deal, it was OK… And if I could predict the future, I’d be a trader, not a salesperson.”