Can You Spell "Bad Valuation Practices?"
.jpg)
Kudos to Sameer Mishra for winning the Scripps National Spelling Bee 2008 after a momentary setback. Initially confusing numnut ("one of little intelligence or thought") with numnah ("a pad that goes under the saddle to keep the saddle clean and to cushion the horse's or pony's back"), this smart 13-year old recovered with aplomb. Click to view his funny response.
Proper spelling remains a passion of mine. I won a dictionary in a national writing contest while in high school, passed AP English with flair and continue to find delight in the written and spoken word. By the way, for those who rely on your computer's spell check function, take note of Janet Minor's homage lesson in poetry. "Bad spellers, untie."
"I have a spelling checker
It came with my PC;
It plainly marks four my revue
Mistakes I cannot sea.
I've run this poem threw it,
I'm sure your pleased too no,
Its letter perfect in it's weigh,
My checker tolled me sew."
Making innocent mistakes occurs. Hey, we're all human. What about errors of judgement when one should allegedly know better? According to New York Times reporter Gretchen Morgenson ("First Comes the Swap. Then It's the Knives," June 1, 2008), UBS and Paramax Capital are duking it out in court over credit default swaps, now a $62 trillion market (based on statistics provided by the International Swaps and Derivatives Association). At the heart of UBS AG v. Paramax Capital Intl., No. 07604233 (NY Supreme Court, NY County, filed Dec. 26, 2007) is whether this large Swiss bank had the right to demand additional collateral from a Fairfield County, Connecticut hedge fund as market conditions moved.
According to Morgenson, "UBS would pay Paramax 0.155 percent of the $1.31 billion in notes annually for its insurance and Paramax would deposit collateral to back the swap, increasing it if the value of the underlying notes declined." What's astonishing is not that the value of the notes declined (credit crisis anyone?) but that the hedge fund (with "just $200 million in capital") found itself facing a shortfall far in excess of the original $4.6 million it used to capitalize the swap.
Our team is trying to get the complaint filed by UBS and the counterclaim filed by Paramax so we can verify who supposedly said what. One assertion (according to the June 1 New York Times article) has a bank executive citing a policy of setting "its marks on the basis of 'subjective' evaluations that permitted it to keep market fluctuations from impacting its marks." Does this mean that positions were artificially valued, regardless of changes in risk drivers? If true, such a policy would be mind boggling at best.
In researching this case, I came across a January 23, 2004 press release in which Paramax Capital Group (presumably the same entity as cited in the lawsuit) announces the launch of a "new multi-seller asset-backed commercial paper program." Part of an effort to satisfy a "need and demand for thirdy party conduits in this new structured finance paradigm," the then Chief Investment Officer for Paramax adds "we think we can provide a high value service and funding to our institutional client base as a complement to their structured finance and funding efforts." One wonders if institutional investors (assuming there were some), allocating monies to Paramax, asked any or all of the following questions:
- How did the hedge fund represent its process of valuing complex instruments?
- Did either the bank or hedge fund employ an independent third party pricing service?
- Did the hedge fund have an appropriate capital risk budget in place?
- How did the bank measure its credit exposure to the hedge fund and to the swap class?
- Who established internal controls (at the hedge fund and bank) to avoid undue leverage?
- How did the hedge fund (bank) measure leverage?
- How did the hedge fund (bank) monitor collateral exposure?
Ultimately, only the trier of fact can and will determine fault (if any) and related damages. "Numnut" was the wrong word for our young spelling champion but it may end up being an apt description for someone, in what sounds like an ugly mess.
