You can read about derivatives (from 1997 to 2001) at the site called DerivativesStrategy.com. The site no longer has up-to-date information but the archives contain a lot of information including an article called The Long-Awaited Arrival of Credit Derivatives by Robert McDermott which describes in detail the rise of credit derivatives and how important these "products" became for the banks.
Another article called F.I.A.S.C.O: An Excerpt published by Joe Kolman explains how a some of the trading deals in derivatives (from 1993 to 1995) worked at Morgan Stanley and how the traders made millions in fees. The writer's descriptions of dealers and traders in derivatives is not pleasant: he talks about how they referred to their skills as being able to "rip someone's face off" or to "blow someone up." He describes how the toxic derivatives in a deal called Pre4 helped make many dealers and executives rich.
It should not surprise you that Goldman Sachs's use of derivatives prepared the way for Morgan Stanley.
F.I.A.S.C.O: An Excerpt
Published by Joe Kolman - DerivativesStrategy.com
In 1992, the Republic of Argentina issued the ugliest bond in history. The enormous $5.5 billion bond issue was popularly known as BOCONs.
The new bonds were issued in various series, one of which, called BOCON Pre4s, was by far the ugliest. It was almost impossible for the owners of BOCON Pre4s to determine what the bonds should be worth, and consequently investors hated them.
The Pre4s were not my first choice when my bosses instructed me to look for a derivatives trade in Argentina. They were too unwieldy. Nevertheless, with the end of the year approaching, we were looking for a home run to ensure that we could claim responsibility for plenty of profits at bonus time. We still were looking for the derivatives group's "trade of the year."
We heard from a client that Goldman, Sachs had recently completed a large derivatives deal in Argentina. One of the DPG salesman quickly obtained a copy of the Goldman prospectus for the deal. It appeared that Goldman had taken some of the BOCONs, simplified them using derivatives, and sold the resulting mix to U.S. investors. They had made the purchase of BOCONs hassle free, and U.S. investors had purchased more than $100 million worth. By our calculations, Goldman had made several million dollars.
We began copying the Goldman deal shamelessly. The idea was simple enough, and Goldman's deal had some structural problems, which we began to correct. Investors loved the deal, and we had no trouble selling it.
The Pre4 Trust fit the pattern of RAVs [repackaged asset vehicles] we had been selling throughout the past year. First we found bonds that were subject to some type of costly investment barrier or restriction in a country outside the U.S. Then we found a way for the investors outside the country to buy the bonds and bypass the barrier. That formula had generated deals with sizable fees. Our trades also typically had one lead buyer, known as the lead order. The Pre4 Trust was no exception, and the lead order came from an insurance company in the heartland. Other Pre4 Trust buyers were more sophisticated.
However, even the most sophisticated investors obviously did not understand the mechanics of the trade. It was incredibly difficult to calculate the value of exchanging the ugly payments for simple payments. We had built an elaborate computer model to make these calculations, but I don't believe any of the buyers were able to create anything similar. If they had, they likely would not have agreed to pay Morgan Stanley several million dollars more than we thought the trust was worth. The excess payments were our fees.
Read the rest of the excerpt here
See the Frontline video here
0 COMMENTS:
Post a Comment