One trading desk does not a battered Morgan Stanley make.
True, there have been plenty of instances in the past where mighty banks have been humbled by the recklessness of a single trader. Nick Leeson makes for the obvious choice, but you can take your pick from others…The Flaming Ferraris at CSFB remain one of our favs.
But the idea that Morgan Stanley’s big $9.4bn Q4 writedown was the fault of just one desk doesn’t quite wash.
Nonetheless, the “desk of shame” trope is doing a tour in print. Take Thursday’s Independent. This is all because of what MS CEO John Mack said on Wednesday’s conference call:
Virtually all writedowns were the result of trading by a single desk in our mortgages business…but I take full responsibility for our performance.
He, and CFO Colm Kelleher repeated that notion again in the Q&A session. And again. It was a message being driven home. So what was, in the end, the long and the short of it? Well MS ended up being long of $14bn of super-senior CDO and short on $2bn mezz ABS CDO.
But that’s not such a terrible call.
Until October/November super-senior CDO exposure (a curio of the synthetic CDO world) was weathered, but holding firm. Mezz CDO paper was the stuff being downgraded by the rating agencies. Mezz CDO paper was - and is - the truly risky stuff, with high subprime exposure. Whereas super senior swaps - in academic terms at least - came with the unofficial tag of being safer than safe; AAA++; untouchable; gilt-like. Why hedge against them? And, more importantly perhaps, how?
But onto the real issue with this “desk of shame” malarkey: it’s unfair to imply that holding super-senior swaps was a short term “trading” decision at all. Referring to it as a single “bet” is slightly disingenious. For a start, why make such a huge, singular bet on such a dull, low-yielding product?
In the past, it was the monoline bond insurers who wrote super senior swaps (more on this issue, in light of Wednesdays downgrades, shortly). Banks weren’t interested because the yields were so low. Banks only became interested when they invented a way of sexing them up. They created leveraged super-seniors - whereby super-senior swaps on synthetic CDOs were collected together into special purpose conduits and geared using commercial paper. (For the curious, details in a thorough post here by Felix Salmon.)
All of a sudden, banks found yet another way they could profit from the origination and sponsoring of CDOs. In general it’s a pretty familiar story. What Merv King -and probably a million other people - call, “the search for yield”. Bank takes low yield boring product, spivs it up, applies leverage, makes money. Yada yada.
What we’re trying to get at here is the fact that Morgan Stanley’s super senior exposure goes way beyond being the responsibility of “one desk”: it’s a pretty accurate reflection of banks’ way of conducting business in general.
