Why There Aren’t Anti-Collusion Lawsuits in the CDO Mess

A lawyer wants to know whether there might be an antitrust or collusion case

to be brought against Wall Street banks in the wake of the CDO mess:

We’re looking into whether, in the wake of Bear Stearns’ meltdown, the major

players in mortgage backed securities market (Bear Stearns, Goldman, Morgan,

Citi, etc.) have agreed to support that market by not selling off their holdings.

Obviously none of them wants to see the CDO market tank, and arguably they’re

doing a good thing by propping it up. But an agreement like that among the

big banks is also an antitrust/market manipulation problem – and the short

sellers in mortgage backed securities indexes (ABX and others) are among those


Both I and the lawyer in question think that this is a very bad idea.

Firstly, the big banks are not generally big holders of CDO tranches.

The whole reason why CDOs exist in the first place is that they’re a mechanism

for moving risk off the balance sheets of the sell side, and onto the balance

sheets of the buy side.

That said, Bear and Goldman and both Morgans all have large buy-side subsidiaries,

which almost certainly do own quite a lot of CDOs, so it might be possible to

make some kind of prima facie case. As a rule, though, the asset-management

arms of these banks are highly insulated from the rest of the bank, and are

certainly unlikely to start colluding with their competitors. Trying to prove

collusion on the buy side would be almost impossible, I think.

Part of the reason is that they don’t need to collude in order to hold on to

their CDOs. CDOs, by their very nature, are a buy-and-hold investment. There’s

almost no liquidity in them, and the explicit tradeoff in the CDO market is

that investors get a higher coupon by giving up liquidity. What’s more, all

CDO tranches are still, for the time being, happily paying their coupons in

full and on time. In such a situation, there’s really no incentive at all for

a fund manager to sell those tranches at a loss.

In fact, as Keith Hahn of Dealbreaker points

out today, money managers have every incentive not to sell their CDOs, to

mark them to market, or to do much of anything, really. Much better to just

head to the beach and work on your plausible denials of any inkling that something

was amiss:

Asked about losses, he says they are there but he doesn’t have to mark to

market his portfolio until someone discovers it or the rating agencies force

his hand. So his plan is to lie low and collect the management fees (and bonus)

and pretend as if there are no losses.

Finally, there’s the fact that it would be really, really hard to demonstrate

damages. You can’t short something which never trades, and as far as I know

no one is writing credit protection on CDOs. There are lots of people writing

credit protection on MBSs, including subprime-backed MBSs, but they’re a different

instrument entirely. Yes, it’s possible that a forced fire sale of subprime-backed

CDOs might result in lower prices for MBSs or the ABX index. But it’s also possible

that it wouldn’t. So it’s hard to say with a straight face that fund managers

not selling their CDOs were responsible for losses (or smaller-than-otherwise

gains) on ABX shorts – especially when the likes of John Paulson

are getting 40% returns in one month from following exactly that strategy.

Paulson, of course, is the fund manager who accused Bear Stearns of a different

kind of market manipulation, although as far as I know he never went close to

taking anybody to court. He’s smarter than that: he knows that courts are unlikely

to have a huge amount of sympathy for short-sellers.

Which doesn’t, of course, mean that there won’t be any lawsuits. In fact, I’m

told by the same lawyer that this very blog entry could precipitate one:

You should also know what might happen — whether or not you think it’s an

antitrust problem, some lawyer at some second rate ambulance chasing plaintiffs’

firm will read your post and file a lawsuit. It won’t be our firm (case is

probably too risky for us anyway), but someone else might well take a shot.

One option is to address the general topic without quoting my question (which

basically invites a lawsuit), and without mentioning magic words like "antitrust"

and "collusion." The ambulance chasing firms monitor blogs etc.

for words like that. Don’t do their work for them. Careful writing on stuff

like this is less likely to precipitate dubious lawsuits.

Frankly, I’m not clever enough to answer this question without quoting it and

without using the magic words. And besides, if I worried about the unintended

consequences of my blog entries, I’d never write anything at all. I also reckon

that it would be reasonably difficult to bring this lawsuit if only because

you’d first need to find a plaintiff. And I can’t imagine there are too many

asset-backed short-sellers who are keen to go down that particular road. So,

a message to any lawyer thinking along these lines: Shoo! Go away! This wasn’t

even your idea to begin with! Find another ambulance to chase!

Do you think that worked?

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