WSJ: Feds Investigating Morgan Stanley CDOs

Morgan Stanley is under criminal investigation for Abacus-like CDO deals, The Wall Street Journal scoops this morning, showing that the scandal is widening on Wall Street after several weeks of reports on investigations of Lehman Brothers and Goldman Sachs.

This one is a cousin of the SEC’s Abacus harges against Goldman (an Audit funder). The Journal reports federal prosecutors are examining why Morgan Stanley created toxic securities, helpfully called the Dead Presidents transactions, bet against them, and—at least some of the time—didn’t disclose that:

One feature of the Morgan Stanley deals was a structure that could increase the magnitude of the bullish investors’ exposures to the underlying mortgage bonds. This feature, which was disclosed in some offering documents, made it more likely that such investors could lose money if the underlying bonds performed poorly.

Morgan Stanley traders took the more profitable, bearish side of these transactions, according to traders. These positions weren’t disclosed in some deals.

One interesting thing here is that apparently Morgan Stanley didn’t market the deals: Citigroup and UBS did. A good line of inquiry for the press would be to find out what Citi and UBS knew and when they knew it. Wouldn’t they have had to have known Morgan Stanley was shorting the deals?

It’s worth noting that Gretchen Morgenson’s (UPDATE: and Louise Story’s) Christmas Eve investigation, which we’ve praised in the past as instrumental in the Goldman charges, also mentioned these Morgan Stanley deals, as Yves Smith points out:

Banks also set up ever more complex deals that favored those betting against C.D.O.’s. Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

The Journal story has four bylines on it and it reads like it was written and edited by committee. It doesn’t get into the meat of what’s under investigation until the thirteenth paragraph:

Among the Morgan Stanley deals that have been scrutinized are the Jackson and Buchanan CDOs, created in mid-2006. Those deals essentially were portfolios of derivatives that aped the performance of dozens of residential and commercial mortgage-backed securities. Morgan Stanley helped to create the deals, which each issued about $200 million in bonds and were underwritten and marketed to investors by Citigroup Inc. and UBS AG, respectively.

Jeez, can’t poor James Buchanan catch a break? He’s already the consensus pick for worst president in history. And Old Hickory is rolling over in his grave right now. Maybe he’ll roll right out and come back to smash the banks again.

We’ll be looking forward to more reporting on Morgan Stanley in the coming days. And the press might want to get ahead of the game on Deutsche Bank, too.

Has America ever needed a media watchdog more than now? Help us by joining CJR today.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.