“Not Only Repo 105”: Total Return Swaps Also Used for Window-Dressing

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.”

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  1. Siggy


    The Lehman Examiner’s Report is a bomb. The report points to multiple gross failures. Jenner & Block have made an enormous gift to the sue-em industry. At the same time the slip-slide-duck-and-dodge folks at the criminal bar have a lovely seed bed from which they can conjure up all manner of “me stupid, not criminal” apologias.

    The question that nags is: When the hell is the Justice Department going to bring actions to court. When is this President going to bring the partisans to the White House and say: “Boys the jig is up. It’s time to set things right some folks have to go to jail”. When is that going to happen? Never because President Obama does not have the support necessary to command a response.

    1. Francois T

      “Never because President Obama does not have the support necessary to command a response.”

      I disagree. Obama has all the support he needs. Hell! 82% of the population (Republicans, Independents, Democrats etc.) say they want Wall Street reformed in depth. If that has to include the perp walk for some, so much the better, since it would radically reset/reaffirm the mass psychology. In other words, it is past due time to prove to the People that bad actions merit bad consequences, not more rewards, just because you happen to be well-connected.

      Obama just doesn’t want to do it, period! He has an “agenda” that apparently exclude fighting for what is right.

  2. Steve

    That is a very interesting look at what is wrong with the financial industry and why we are where we are today.

    Is it sad that it isn’t surprising in the least?

  3. paul

    For individuals, this kind of thing is known as a wash sale, and reporting it as a real one is fraud. Good thing corporations are persons under the law, or they could play by a completely corrupt set of rules.

    What we really need is a high-return career path for independent auditors and regulators. Otherwise you’re just going to get capture either in the present (you don’t get the gig unless you play along) or future (you don’t get the vp job at the company you used to regulate unless you play along). For a while it seemed as if litigation might be that path, but not so much.

  4. Uncle Billy Cunctator

    Maybe some others are having this issue too: the posts are getting longer and more must-readable, but I’m getting more and more hesitant to read them because graphically they’re so ragged. Is it easy to right justify the column? The brain simply resists all the indentation from the left and the right.

    1. Yves Smith Post author

      Uncle Billy,

      I’m sorry, but McKinsey (which has long spent a fortune on studying the use of graphics in communications) and most major law firms in their client documents do not right justify. A large body of research shows it is harder to read due to irregular spacing between words and in some readers lowers reading comprehension.

      Newspapers right justify to save on printing costs, and that remains the convention for online versions of newspapers and magazines. It signals “professional layout” but is actually harder to read, even though it does look much prettier.

      1. Uncle Billy Cunctator

        McKinsey? The folks who have been advising american corporations as we descend into the biggest depression the world’s ever known?

        So what is it? Both Baseline and Lord Scunchington’s (Salmon’s) blog are ragged on the right, but maybe they both leave the impression of being much cleaner. Maybe it’s the surrounding elements? All I really know is that I’m beginning to resist coming to read here. Since I’m the only one to comment on this, it might just be my issue though. Take it for what it’s worth. Best, UBC

  5. rita

    Maybe we need a complete overhaul of accounting rules. The preamble to the new set of rules should be: “Liars figure and figures lie. Believe financial statements at your own risk.”

    Despite the accounting chicanery there does seem to be some unwritten understandings among the denizens of Wall Street. Otherwise how can one account for those who toward the end wouldn’t touch Lehman with a ten-foot pole? The proverbial “word on the street” must be based on some understanding about what firms are healthy and what firms are using accounting tricks to mask underlying disease. Now, if only, we could get regulators and boards of directors to listen to and understand the “word on the street”, we might be headed in the right direction.

  6. bird

    The changing definition, compulsion to abbreviate, catch phrases, and anything else that can be used to distort a word, is likely how we got in to this mess we are facing. Words in complete sentences and paragraphs are far more informative for the reader, and don’t allow for as much interpretation of implied meaning by the author.
    Let us hesitate to condense that which requires the unabridged?

  7. Doc MadCow Holiday

    Meanwhile, over at AIG, the madcow burger is still being churned out at high speed, through the AIG Grinder, which is tainted, un-cleaned, un-regulated and highly toxic — but that doesn’t keep Timmy and Ben away from the BBQ:

    In addition to these traditional actuarial methods, AIG’s actuaries utilize ground-up claim projections provided
    by AIG claims staff as a benchmark for determining the indicated ultimate losses for all accident years other than the
    most recent accident year.


    * The author also believes the Treasury Yield Curve is tainted with linear interpolation and crap like that which distorts the future value of economic value. The author also has doubts about discount rates and valuation models in general but has made a choice to sit on the sidelines and watch the parade of corruption eat away at the foundation of America…..

  8. MIchaelC

    Since you’ve brought up TRS (Total Return Swaps) in regards to window dressing, its worth mentioning the window dressing possibilities are only one piece of the story.

    TRS were used, like CDS, as a vhecle to obtain insurance on portfolios of assets originated at the banks. Unlike CDS, the underlying are not securities, but pools of unsecuritized assets.

    TRS were used in Structured Notes programs whereby the Noteholder would pay the TR (read, losses)on the pool of assets to the origninator in exchange for a steady fixed rate (similar to synthetic CDOs)

    These programs are unconsolidated by the sponsors, since as the protection buyers they were not the primary beneficiaries of the sponsored entity. However, they are material and are disclosed in the 10K of the sponsor and discussed in the Variable Interest Entities footnotes.

    I’m familiar with their role in structured notes, less familiar with pure trading TRS portfoios.

    Since the TRS provides protection similar to CDS, it would be interesting to see how large the TRS trading books are at the major players.

    1. vlade

      TRSes can be done on just about anything – from toxic stuff to commodities to just about anything that can be bought or sold.

      I can think of few legitimate uses for TRS (getting exposure to hard-to-get assets, getting better funding terms), but for each one I can come up with 10 which are effectively balance-sheet/regulatory arbitrage, and serve no good economic goal.

      They are not nearly as liquid and tradeable as CDSes though.

    2. MIchaelC

      Sorry, one clarification,
      I said -Unlike CDS, the underlying are not securities

      I meant to say, the transactions I was discussing did not include securities. I wanted to be clear that I was making an observation based on my limited experience, not refuting the authors point that TRS was written on all kinds of drek.

  9. David Merkel

    Anytime there is a guaranteed buyback, it is improper to do sale treatment, unless there is some economic substance to do the two transactions, leaving aside tax and regulatory reasons.

  10. cvtulley

    I thought these wall street morons would have got the message when George Bush refused to pardon Scooter Libby. Where is George Bush when you need him

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