Wednesday, November 21, 2007

Liquidity Put

Thought we took care of all that.

Investment banks are only now disclosing their real losses, and it echoes the accounting scandal that brought down energy giant Enron Corp. in 2001. Many investment banks sold mortgage bonds with a little-known take-back provision — called a liquidity put — that never appeared on balance sheets. It allowed investors to return the bonds if the market sours. Banks are suddenly writing down the value of their assets to the tune of billions of dollars.

"We thought after Enron that we had put an end to off-balance-sheet financing," said Coffee, who added that even directors of some investment banks were unaware of the take-back provisions. "Just six years after Enron we're seeing some of the same problems surface."

Basically the "liquidity put" involved investment banks taking a piece of the shitpile, offloading it to someone, but then promising to buy it back at a given rate if it tanked in value. Because of the Magic of Modern Accounting, they would do this to take bits of the shitpile off their books, even though it meant that the worst of the shitpile - the stuff which would tank - would inevitably return to their books in the future.