Goldman Sachs and one of its Structured Finance Vice Presidents, Fabrice Tourre, were sued in civil court by the SEC for fraud on Friday, April 16, 2009 regarding representations that they made in the marketing and offering materials for what is known as a synthetic CDO named Abacus 2007-AC1. This news has sent the Goldman Sachs common stock lower by more than ten percent. It is also significant implications as the investigation is said to be still open and on-going.

Toomre Capital Markets LLC ("TCM") has received several messages looking for more insight on this latest questionable activity in the mortgage and structured finance markets. We have been busy on a detailed review of the detailed Exhibits related to the Examiner's review of the Lehman Brothers bankruptcy. We will shift our focus and hope to shortly have some further insights posted here.

Toomre Capital Markets LLC ("TCM") first wrote about the use of credit default swaps ("CDS") as a means of insider-trading back in October 2006 in the post Possible Insider Trading Using Credit-Default Swaps?? On May 5th 2009, the Securities and Exchange Commission finally filed its first case alleging that credit-default swaps were used to facilitate illegal insider-trading activities. Hopefully, this will be just the first of many such cases filed involving the abuse of insider information and the credit default swap market.

According to this story on Bloomberg News written by David Scheer, the SEC has now alleged that a Deutsche Bank AG salesman, one Jon-Paul Rorech, 36, passed on information about a pending bond sale to a now former Millennium Partners LP money manager, one Renato Negrin, 45, who then bought credit default swaps that resulted in profits of $1.2 million once the VNU high-yield bond transaction was formally announced. The securities market regulator wants these two individuals to forfeit "unlawful trading profits" and pay unspecified fines. “Rorech and Negrin checked their integrity at the door and schemed to engage in insider trading of CDS to the detriment of investors and our markets,” Scott Friestad, the SEC’s deputy enforcement director, said in the statement announcing the lawsuit.

Toomre Capital Markets LLC ("TCM") has previously written favorably of New York Federal Reserve President Timothy Geithner in the posts Bear Stearns: U.S. Banking Committee Starts Looking At Regulatory Change and Suggested Reading: Timothy F. Geithner Speech on Credit Derivatives. New York Fed President Timothy Geithner has been the Federal Reserve's point person dealing with Wall Street during the on-going credit crisis that seemingly started last year with the collapse of two Bear Stearns hedge funds that were highly leveraged and highly exposed to sub-prime mortgages and Collateralized Debt Obligations ("CDOs"). His active involvement in trying to stabilize the bursting of the housing bubble culminated with his prominent involvement with the March 2008 rescue of Bear Stearns which is expected to formally taken over by J.P. Morgan Chase & Co. on Friday, May 30^th 2008.

Since the Bear Stearns rescue effort unfolded in mid-March, there has been considerable criticism of the Federal Reserve and Treasury Department brokered sale of Bear Stearns to JP Morgan, particularly around the issues of moral hazard and the Federal Reserve's ability to act as an 'honest broker' in future financial crises. On the front page of the May 30^th 2008 edition of The Wall Street Journal, there is an article written by Greg Ip entitled Fed's Fireman On Wall Street Feels Some Heat that summarizes some of the criticism still being directed at Timothy Geithner. The article contains the interesting reference that "As early criticism of the rescue swirled, the president of the Dallas Fed, Richard Fisher, sent Mr. Geithner an email in Latin: 'Illigitimum non carborundum,' along with his translation, 'Don't let the bastards get you down.' Mr. Geithner replied that his grandfather had the same slogan on his kitchen wall."

Toomre Capital Markets LLC for one is glad that Mr. Geithner pushed for the Federal Reserve to lend $29 billion to JP Morgan to facilitate the latter's takeover of Bear Stearns on Sunday, March 16^th 2008. Although some rather ignorant Congressmen claimed that the Federal Reserve's participation "exposed the American taxpayers to unknown amounts of financial loss", TCM is sure that such politicians would have been singing a much different self-serving tune had Bear Stearns filed for bankruptcy early the next Monday morning. Many people who are not intimately involved with the Capital Markets do not appreciate how intricately the various investment and global commercial banks have become through derivative contracts and particularly what are known as Credit Default Swaps ("CDS").

On April 16^th 2008, the International Swaps and Derivatives Association, Inc. ("ISDA") released the results of its Year-End 2007 Market Survey of privately negotiated derivatives. In that report, IDSA reports "The notional amount outstanding of credit default swaps (CDS) grew 37 percent to $62.2 trillion in the second half of 2007 from $45.5 trillion at mid-year. Further CDS notional growth for the whole of 2007 was 81 percent from $34.5 trillion at year-end 2006. The survey monitors credit default swaps on single names and obligations, baskets and portfolios of credits and index trades." [Emphasis added]

Holy crap! No wonder there was so much concern about counter-party risk a month ago when a "run on the bank" which led to the acquisition of Bear Stearns by JPMorgan. Toomre Capital Markets LLC ("TCM") now even more appreciates the efforts of the President of New York Federal Reserve, Timothy Geithner, to clean up the credit default swap middle and back office operational issues. With growth this explosive, the major investment and global banks are particularly interconnected. From a moral hazard perspective, due to their derivatives exposures, are not all of these banks "too big to fail"? Or does this explosive growth suggest that the Capital Markets finally needs a global clearing mechanism so that there is more price transparency on what specific derivatives are worth and that there is less counter-party risk in the financial system?

On Thursday April 3^rd 2008, there was enlightening testimony before the United States Senate Banking Committee regarding the acquisition of Bear Stearns by JPMorgan with the assistance of the New York Federal Reserve (and potentially ultimately the U.S. Treasury and common taxpayers). The first panel was composed of Federal Reserve Ben Bernanke, SEC Chairman Christopher Cox, Federal Reserve Bank of New York President Timothy Geithner and Treasury Undersecretary Robert Steel. The second panel consisted of JPMorgan Chase CEO Jamie Diamond and Bear Stearns CEO Alan Schwartz. Toomre Capital Markets LLC ("TCM") thought that a couple of key items emerged from the testimony of these two panels:

• Bear Stearn's liquidity disappeared virtually overnight declining from $12 plus billion to about two billion on Thursday, March 13^th.

• Federal Reserve Bank of New York President Timothy Geithner is really impressive and clearly a heavy-weight. Toomre Capital Markets LLC previously highlighted his speech on the credit derivatives issue in the post Suggested Reading: Timothy F. Geithner Speech on Credit Derivatives. TCM is quite reassured that this regulator is at the helm of the Federal Reserve Bank of New York during this time of credit crisis.

• The various regulators were not prepared to deal with a liquidity crisis at one of the primary dealers (and it is not clear if they have the authority to do so going forward).

• At the invitation of the SEC, Federal Reserve examiners are now on site daily at the top five investment banks: Merrill Lynch, Goldman Sachs, Lehman Brothers, Morgan Stanley and Bear Stearns. While the Federal Reserve officials do not have the authority to direct the investment banks to follow its directives, one can be assured that the Federal Reserve holds one very critically key trump card: The Federal Reserve is not required to lend to any institution and critically is unlikely to do so to any institution that it deems as "unsafe". Hence, if the investment banks want access to the Federal Reserve discount window, one can be rest assured that they will be following the Federal Reserve's "suggestions."

Toomre Capital Markets LLC ("TCM") has long been concerned about the opaqueness of the Credit Default Swap market. As this market sector has exploded in size in the past decade, TCM has feared that some losses from these credit derivative instruments may be hidden from investors, regulators and counterparties. Hence, the soundness of the global financial system might well be less sound than what international regulators, rating agencies and large financial institutions might think.

Others have been concerned too. The Australian has started off the 2008 New Year with a rather ominously entitled article Forget CDOs, Is is Time for CDSs. The article starts with "If 2007 was the year of the CDO, the latest acronym to loom dark and large on the financial markets' horizon for 2008 is the CDS. And the CDS (credit default swap) is shaping up to be far more noxious than its little derivative brother, the CDO - a spliced and diced bundle of mortgages known as a collateralized debt obligation that sent Wall Street into a tailspin last August when the market for low-grade US mortgages froze over. At least Warren Buffett seems to think so. After the world's top two bond insurers were scolded with [the threat of] a ratings downgrade last month and told to go and raise some capital, the visionary Buffett revealed last Friday that he was to set up a bond insurance business." [emphasis added]

The key point of this article is that "the murmur among the cognoscenti is that an implosion in the CDS market could do serious damage to the international banking system." They have slightly misquoted Warren Buffett who did say "We felt that, in many cases, the prices that people were charging were inappropriate." What Mr. Buffett was referring to was the cost of credit enhancement insurance to ensure that a municipality's debt was paid on a timely and ultimate basis that is part and parcel of a AAA/Aaa rating. He was not referring to the prices of CDS transactions. However, the article authors were correct that the crux of the problem is that there is not only price transparency but there also are problems about reserving and regulation.

Toomre Capital Markets LLC ("TCM") made a post back on November 3rd 2007 entitled UBS Has a "SMALL" VaR Risk Modeling Problem. A key point in that post regarded how badly the UBS investment bank' risk management area missed in the calculation of the bank's economic risks. For instance, the third-quarter UBS economic report card revealed that the bank's trading areas had sixteen trading days out of sixty-three or so where the daily losses exceeded that projected by the daily Value-at-Risk ("VaR") at the 99% confidence interval level. With the December 10th 2007 announcement of its additional $10 billlion in losses at UBS, no doubt there will be a number of days during the fourth quarter where the actual losses will exceed the calculated VaR. An interesting question still to be answered is how many days did they miss on?

Probably the most key parameter for any VaR model is volatility, both in the size of positions and in the prices at which those positions are marked. Likely, a key reason why the UBS risk management area missed on so many days during the third quarter is that their volatility estimates of prices were simply averages of the last five years of observations and did not give extra weight to the recent period when prices began to deviate significantly from the near par prices. CDO prices have now been declining for several months and there is considerable question about what the heck CDOs are worth and what should be used in various analytical risk models.

For counter-parties and investors, a key question remains after the $10 billion write-down announcement at UBS. What amount of subprime investments and CDOs does UBS still own, and perhaps even more importantly, where are they now valued?

On Monday November 19th 2007, Swiss Re, the world's largest reinsurer, announced that it had lost 1.2 billion Swiss francs (or $1.07 billion U.S. dollars) on two credit default swap contracts in October after the U.S. subprime mortgage crash and Collateralized Debt Obligation ("CDO") devaluations roiled debt markets worldwide. The losses occurred on two credit-default swap contracts that the Swiss Re financial services division sold to protect its clients against declines in investments backed mostly by mortgages.

Toomre Capital Markets LLC ("TCM") wonders why Swiss Re was taking on such large notional swap contracts since they are so far removed from Swiss Re's primary business of reinsuring traditional property and casualty risks. Lars Toomre previously worked in the American Re Financial Products group (part of the Munich Re group) and does not recall any traditional insurers with such large notional amount needs.

On the other hand, TCM is aware of one group of insurers that surely would have liked to have had access to the reinsurer balance sheets: the mono-line financial guaranty companies like Ambac, FGIC and MBIA. Did these mono-line insurers lay off some of their subprime and CDO risk to Swiss Re financial products? If so, the recoveries due to these credit default swaps surely would help the capital situation at whichever mono-line insurers entered into such risk transfer strategies.

On Thursday November 8th 2007 at 12:40 EST, Bloomberg News ran this little story by Cecile Gutscher: Insured CDOs May Have AAA Ratings Cut Four Levels, Fitch Says. Toomre Capital Markets LLC just three hours earlier posted a note entitled Incestuous Mix: Structured Credit, Financial Guarantors and Rating Agencies that was focusing on what might happen if the financial guarantors were downgraded.

Apparently, if you were an investor in collateralized debt obligations that were rated AAA because of guarantees issued by bond insurers including MBIA Inc. and Ambac Financial Group, Fitch Ratings has now decided that the credit ratings may be cut in one swell swoop by as much as four rating levels. According to this Bloomberg article, Fitch rating analyst Thomas Abruzzo said in an interview today that "We expect there could be situations that could lead to downgrades of three to four notches on insured structured-finance CDO transactions."

New York-based Fitch said Nov. 5 it may lower the top ratings of bond insurers after a review that takes into account the CDOs they guarantee. Any bond insurer that fails the new test may be downgraded within a month unless the company is able to raise more capital. ``The bond insurers themselves remain AAA but there is the potential that companies could fall short of capital and also be downgraded, but we don't expect below the AA category,'' Abruzzo said. AA is the third-highest investment grade.

Oh well… There goes another linchpin under the high-grade bond market. No longer can one buy an insured bond and assume that the bond will remain in its original rating category throughout its life cycle. Perhaps someone can now suggest what credit enhanced bonds are really worth??? Does a AAA credit rating really mean anything??? Shouldn't AAA-rated structured finance transactions trade more cheaply than AA-rated corporate debt, or maybe even A-rated corporate debt? Or maybe it really is worth JUNK???

After all, one has to use one of those modern computers to calculate the value of the structured finance security? There is no absolutely transparency like there is in whether a company might be able to pay back its debts! The structured finance market used to have some degree of trust. With these dramatic ratings downgrades in portfolios that traditionally have seen small changes in principal value, is there any question about why there is a complete breakdown in reputation and trust? Widows and orphans bought high-grade bonds because of their high quality and predictable cash flows. What is a rating worth if it can go from AAA to BB on one Friday afternoon? What the heck good is bond insurance if a rating agency can suddenly bring down the rating of the insurer and all of the insured bonds that it backs? In short, What good is a credit rating?

The Stamford, Connecticut chapter of the Professional Risk Managers' International Association ("PRMIA") held a very informative meeting on Wednesday, November 7th 2007 entitled "The Emperors' New Clothes?: After the Credit Crunch, What's the Future of Structured Credit, Financial Guarantors and Rating Agencies". Toomre Capital Markets LLC ("TCM") thought this was one of the most informative industry events yet and strongly recommends that the reader pay close attention to the incestuous circle of structured credit, financial guarantors and rating agencies. The speakers were:

• James Chanos – Managing Partner, Kynikos Assocaiates
• William Ackman – Managing Member, Pershing Sqaure Capital
• Edward Grebeck – CEO, Tempus Advisors

Some readers no doubt will recognize James Chanos and his fund Kynikos Associates as one of the most prominent short-seller hedge funds. Bill Ackman and his hedge fund Pershing Square Capital are primarily focused on the long side, but does have substantial short interest in the financial institution, rating agency and financial guarantor sectors. Bill is perhaps most well known for his excellent (and very negative) research report on MBIA from several years ago. The FORTUNE magazine article from May 16, 2005 entitled The Mystery of The $890 Billion Insurer has more information.

During the trading hours of November 7th, equities in the financial sector were under considerable pressure. This pressure is primarily tied to the great uncertainty about just what are Collateralized Debt Obligations worth, where the resulting large losses are buried and what are the secondary repercussions of the sub-prime meltdown, such as SIVs, option ARMs, and commercial mortgage credit-worthiness. After the close, American International Group ("AIG") reported 3rd quarter results that fell short of expectations primarily due to their losses from the mortgage markets. Then, Morgan Stanley ("MS") pre-announced that it be taking a $3.7 billion in losses in its proprietary trading businesses tied to principal investments in CDOs and other sub-prime mortgage-backed securities. (This amount may change over the balance of November until the end of Morgan Stanley's year end.)

Against this backdrop, James Chanos and William Ackman suggested that the markets are still in the early innings of this mortgage credit crunch process. Whereas some analysts have been suggesting as many as 1.5 to 2.0 million families may lose their residencies due to foreclosure in this mortgage credit cycle, their collective view is that the base level of foreclosures will be much worse, perhaps approaching 3.5 million or even 4.0 million incidents. They suggested that the collective market does not yet appreciate that things could get that bad nor have financial professionals begun to fully appreciate some of the national political repercussions of so many people losing their homes.

Toomre Capital Markets LLC ("TCM") has been extremely concerned about the Structured Investment Vehicle ("SIVs") and their large holdings in supposedly safe collateral such as Super Senior, AAA-rated and AA-rated Collateralized Debt Obligations ("CDOs"). On Wednesday November 7th 2007, Moody's started the final crash of the SIV market with ratings action on $33 billion in SIVs, including several SIVs affiliated with Citigroup.

According to this news article, "'SIV senior note ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt,' Moody's said. … SIVs would be hurt by 'further deterioration in the market value of the portfolio,' resulting in losses on capital and senior notes if they have to sell holdings in an unfavorable market."

Specifically, Moody's downgraded the SIV called Victoria Finance Ltd. Further, Moody's placed on review for possible downgrade several other SIVs including:

• Harrier Finance Funding Ltd.
• Orion Finance Corp.
• Carrera Capital Finance Ltd.
• Beta Finance Corp.
• Centauri Corp.
• Dorada Corp.
• Tango Finance Ltd.
• Asscher Finance Ltd.
• Cullinan Finance Ltd.
• White Pine Corp.
• Hudson-Thames Capital Ltd.
• Nightingale Finance Ltd.
• Links Finance Corp. and
• Premier Asset Collateralized Entity Ltd.

The SIVs Beta, Centauri and Dorada are three of the seven SIVs that Citigroup manages and were placed on credit watch for possible (and likely probable) downgrade. The reader should remember that Citigroup had pledged that it would provide up to $10 billion in credit support to its SIVs. According to this Bloomberg article, Citigroup already has drawn down $7.6 billion of this credit support facility as of month-end October.

Toomre Capital Markets LLC is a specialist in structured finance and risk management. Any potential clients or service providers (like fiduciaries, accountants and/or legal advisors) are welcome to contact TCM at the information below for how Lars Toomre or Aldon Hynes can help your organization in these times of extreme stress. Please feel free to contact us or leave any thoughts or comments.

Reuters is reporting the obvious on Monday, November 5th, 2007: Cantor CEO says big CDO market has shut down. Apparently Cantor Fitzgerald LP Chairman and Chief Executive Howard Lutnick publicly has stated what Toomre Capital Markets LLC ("TCM") and many others have been saying for several weeks now: There are effectively no buyers and what people and organizations own on their books in CDO format, sub-prime mortgage format or just as general collateral has one place to go: DOWN.

The complete CDO market seizure means that there still are tremendous losses to come for those financial intermediaries that retained CDO bond classes, those investment portfolios that invested in them and, perhaps most importantly, all of those organizations that put on CDO "arbitrage" strategies. Perhaps people have not fully appreciated the full impact of this credit crisis? Maybe $25 Billion of the originally estimated $100 Billion dollars in losses have been reported by investment banks and global banking institutions. Where is that $75 Billion in other losses lurking? And assumes that the original $100 Billion number was even conservative enough… Some are already speculating that the total losses from CDO investments may total more than $250 Billion.

"The big CDO market is gone," Lutnick told the Reuters Finance Summit. "You'll see all the banks step out of it because they just can't do (the deals anymore) because they won't be able to churn them out to the buyers because the buyers are gone." Lutnick, whose firm controls one of the world's largest bond brokerages, said the easy buyers of CDOs have left the market. That leaves what he described as sophisticated buyers, who are willing to do their own math and find their own value for distressed CDOs. That will spawn a market for packaging the securities in a way that appeals to those investors, Lutnick said.

"The (CDO) repackaging business will be there, and it will grow enormously," Lutnick said. "No one is going to believe anybody anymore (about CDOs)," Lutnick said. "It's not just about the rating. You have to run your own math and come to your own view."

On Tuesday October 23rd 2007, The Telegraph newspaper out of the United Kingdom states in an article written by Ambrose Evans-Pritchard that a New Credit Crunch Looms. The article suggests that fresh turmoil in the global debt markets has set off sharp falls in commodity prices and higher-risk assets as investors scrambled for the safety of relative safer investments.

In one of the most dramatic currency moves of the year, the dollar soared as US investors liquidated foreign holdings, ending at $1.4129 against the euro and £2.0276 against the pound. Libor spreads in Europe's interbank market jumped to 64 basis points, roughly the level that set off the credit crisis last summer and prompted a liquidity rescue by the European Central Bank. The iTraxx Crossover index that measures spreads on corporate bonds has jumped 100 basis points since last week to 364 bp yesterday.

"It's the summer that won't end," said Peter Berezin, a strategist at Goldman Sachs. He said investors were shaken by last week's drop in US home-builder sentiment to an all-time low and by fresh falls in the ABX index for sub-prime debt. "We continue to learn that it pays to respect the sell-offs in ABX and housing-related credit. This has elements of the February and August sell-offs, where credit markets signaled problems," he said. The lowest tier of ABX debt has fallen to a record low of 20.72 – from par of 100 – pointing to huge losses that have yet to surface.

Toomre Capital Markets LLC ("TCM") has been very concerned about the evolution of this credit crunch and has privately argued that it is very much like a slow motion train wreck. Unlike some of the market sectors like United States equities where the markets seemingly quickly react to market moving news, the credit markets, and particularly the primary mortgage market which is composed of many, many local markets, react much more slowly. It takes considerable time for the delinquencies to first appear and then the stress of missed payments to turn into actual foreclosure actions. It also takes some time for individual homeowners to realize that the prices of their homes may not longer be appreciating, and seemingly often most recently, the value of the homes has in fact declined. It is psychologically hard to sell an asset at a loss and TCM suspects that many homeowners will hold off on selling homes in which they have a loss. Hence, the true state of both the magnitudes of the delinquencies/foreclosures as well as the losses given default are not likely to be known for some weeks and even months to come.

Toomre Capital Markets LLC (“TCM”) has written previously about how many people are employed by the Wall Street structured finance deal machines in the post Can Wall Street be Trusted to Value Risky CDOs? Today rumors are flying that major layoff announcements are about to be implemented by many of the big investment banks. Supposedly, many of the well-paid investment banking personnel focused on structured finance will be let go within the next few weeks.

During the past few weeks, various portions of the credit markets have seized up, particularly in the structured finance sectors like non-conforming mortgages, Collateralized Debt Obligations (“CDOs”) and Asset-Backed Commercial Paper (“ABCP”). Rumors are rampant about the big losses being suffered by the structured finance areas of various investment banks and hedge funds.

There have been all sorts of crazy talk about how much this or that firm has lost. Some rumors suggest that many smaller hedge funds have suffered losses since Memorial Day in excess of 25%. The numbers being tossed around are literally hundreds of millions of dollars and the investment banks collectively are said to have lost a low ten billions of dollars.

The morning of Thursday, July 26th began with a front page story in The Wall Street Journal entitled Banks Delay Sale of Chrysler Debt As Market Stalls. Written by reporters Dennis K.