FrontPoint and Scion Capital must deal with rising prices in their shorted

Frontpoint and scion capital must deal with rising

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FrontPoint and Scion Capital must deal with rising prices in their shorted securities in early 2007, requiring payments of collateral and carrying feesS&P will not admit that the agency ever refused to rate the top tranche of any CDO or MBS security as investment grade. This is because the banks were able to “shop around” for the best rating on the securities, so if S&P did not give the securities the desired rating, they would go to either Fitch or Moody’s in an attempt to secure a better oneSEC, due to budgetary constraints, did not investigate any disclosure or trading practices having to do with mortgage bonds or anything in the industryThe market for synthetic CDOs and mortgage-backed security insurance are approximately 20x the size of MBS and CDO market itself, creating massive leverage and liability and systematic instabilityBanks did not begin to devalue their MBS swaps until they got them off their balance sheet and into the portfolios of retail investors who could not possible fully understand what they were buyingMorgan Stanley owns long positions as the counterparty to the CDO and MBS swapsViolations of the Reasonable Person Assumption and Expected Utility TheoryBanks lent to increasingly unqualified candidates, creating excessive default and liquidityrisk. These lending practices would be considered irrational because the maximization of self-interest would be to receive the full principal amount and interest payments, but the unqualified borrowers have a lower likelihood of repaying their loan. Investors and speculators in the housing market (those who longed MBS), did not do a fundamental analysis on the individual components of the pooled bond securities. A rational person would seek to downsize their risk as much as possible per unit of return.
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