It appears JP Morgan Chase is a vampire squid as well.
JPMorgan will pay a $153 million fine to settle Securities and Exchange Commission charges that it misled investors in a mortgage bond deal just as the housing market was about to crack. The SEC alleges that JPMorgan sold a type of risky mortgage deal called a collateralized debt obligation to investors without admitting that the bonds in the deal were selected by a hedge fund, Magnetar Capital, that was positioned to profit if the deal were to fail. That meant Magnetar had every incentive to pick the worst bonds it could find. And apparently it did. JPMorgan sold $150 million worth of bonds based on the Squared CDO 2007-1. Those bonds are now nearly completely worthless. Magnetar reportedly made as much as $600 million on the deal. Among the investment firms and their clients or investors who where wiped out are Thrivent Financial and GM’s pension fund.
The deal and the charges against JPMorgan are very similar to the case the SEC brought against Goldman Sachs last summer. And they were based on a basic, well let’s say logical flaw, but it was really a boldfaced lie, in the way investment banks market these complex bond deals. I remember covering CDOs back in 2006 and 2007. Something investments bankers always told me was that they were safer than typical mortgage bond deals because they had managers. A regular bond deal was made up of home loans that an investment bank cobbled together and then sold to investors. Some bonds default. Some people paid off their mortgages early or refinanced. But in general the bond pool was as they say static. It remained the same.
CDOs were different. They had a manager, like a mutual fund. The manager had specifically picked bonds for the deal. And even after it was sold, the managers were able to swap bonds in and out of the porfolio, in order to protect investors from losses. So what happened to mortgage-backed CDOs. They were some of the worst performing bond deals ever. In fact, the CDO managers made the deals much riskier. Once the housing market overheated it was obvious to the smart people that you could make a lot more money betting against mortgage bonds than investing in them. A couple of CDO managers realized that, and once they had placed their bets against their own deals they had no incentive to protect the investors in it. But even the CDO managers who didn’t bet against their deals had no incentive to actually protect investors. They weren’t paid on performance, just maintenance. And they hadn’t sold the bonds anyway the banks had.
There are a lot of problems here that investors could learn from. First of all, be wary of investments in which Wall Street says you have an extra layer of protection. The financial hucksters are probably trying to distract you from how risky the investment really is. Second, when there is a manager involved in a deal, you should buy the investment directly from the investment manager. The SEC hasn’t brought suit against Magnetar, in Goldman’s case John Paulson, because they didn’t sell the deals, so they didn’t have any fiduciary responsibility to the end investor. That freed them up to do the things like bet against their own investors. Just because someone else is supposed to be managing your money in your best interests doesn’t mean they will. When it comes to making sure you don’t lose your money, you are the only money manager that matters.