Mount Desert Island, Maine—On the heels of the mortgage sector meltdown, the financial sector was rocked today by another round of write-downs at the bulge bracket banks. At a press conference yesterday, G. Steven Rowe, Attorney General of Maine, announced that JP Morgan (JPM) and Morgan Stanley (MS) had agreed to buy back $7 billion in lobster-backed securities as part of an agreement to end probes by state regulators into how the complex securities were marketed to investors.
According to the agreement, these collateralized lobster obligations, or CLOees, were “presented to investors as triple-A prime investments and packaged in wicker baskets with clams, mussels, a Maine-made dessert, cooking instructions and a gift card, plus free shipping.” Attorney General Rowe added that "when the market for these recently caught derivatives dried up, the investor was left holding the bib.”
The complexities of crustacean securities are often daunting even to regulators. Legally, a CLOee is a special purpose entity wholly separate from the institution that creates it. The entity is the legal owner of a set of lobsters, called a pool. Investors in a CLOee buy lobsters issued by the entity, and receive ramekins of melted butter according to a defined set of rules. The lobsters themselves serve as collateral, and the set of rules that dictates how money received from the collateral will be distributed is called the structure. The legal entity, collateral, and structure are collectively referred to as the "deal-e-o," and often ensure that the average investor will end up caught in a trap.
Though the settlement today indicates that legally the two firms are in pretty hot water, neither admitted wrongdoing as part of the agreement. Bryson Ready, a lobster man turned investment banker and head of Morgan’s Maine derivatives trading desk, said the temptations can be great in such a high-risk sector: “Fog, salt air, waves crashing over the bow, sea spray in your face...it’s an addictive lifestyle. Not to mention the lobster.”
Attorney General Rowe was not swayed with such excuses. “Never have I seen such upstanding companies act so shellfish,” he said.
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