Sunday, June 14, 2009

The Kenosha School District Is All About Riskless Subprime Synthetic CDOs

The latest casualty in the synthetic CDO/subprime implosion is the State of Wisconsin's Kenosha Unified School District. Although seeing how the school district has launched an all out lawsuit against Stifel Nicolaus, and more specifically its then-SVP David Noack, as well as RBC, for selling them synthetic CDOs as "riskless," in which the school districts ended up investing $200 million, this one could be tricky - is it the schools' fault for not doing any homework before investing essentially all their OPEB offsets into some credit-bubble-peak zany scheme, or Stifel's for taking advantage of gullible investors and misrepresenting associated risks.

Some of the main highlights from the lawsuit:
When questioned by the Plaintiffs about the make-up of the underlying collateral, and the potential existence of any sub-prime debt, Noack contacted Deb Pederson of RBC Global with that inquiry. Ms. Pederson assured Noack that the CDO had no direct exposure to sub-prime debt in the portfolio. Noack then represented to Plaintiffs that there was no sub-prime debt in the portfolio. This representation on the part of Ms. Pederson was materially false and known by her to be false at the time it was made, in circumstances where she well knew the information would be communicated to Plaintiffs, and that Plaintiffs would rely on it.

Regarding the nature of the CDO investments and their attendant risks, Defendants and their agents, including Pederson, Noack and Brewer, made numerous false representations to each of the School Districts, including but not limited to, misrepresentations that used the following words or words to that effect:

• “On the investment side, we’re sticking to AA/AAA.”
• “These are safe AA/AAA type investments.”
• “It’s a AA rated investment [and . . .] meets statute prior to new rules that allow you to invest in anything, so we’re staying on the conservative side.”
• “It takes 20 out of these 100 companies to default before it gets to your AA level.”
• “There would need to be 15 Enrons before you would be impacted.”
• “We’re taking very little risk in AA and AAA securities and what we make is as risk free as we can get with AAA and AA.”
• “The biggest risk, not the credit risk, since we’re sticking to AA, but it’s the mark to market where the valuation of these investments can fluctuate based on supply and demand and interest rate, but it has nothing to do with the fact that you’ll still get your money back at the end.”
• There is no sub-prime debt within any of the CDOs.

One can bet their bottom hyper-de/inflated dollar that this is not the last case where some pension administration will have invested all their (leveraged) money in order to offset pension obligations. Kenosa is merely one of the thousands of such cases where the investors will gradually uncover that all their invested capital, which was supposed to return a guaranteed x % a year, is now forever gone. And while innocent school and other non-profit organizations are likely to suffer substantially, it is also the case that corporations will soon find themselves at the mercy of their pension obligors once the latter uncover that there is no capital left to satisfy their happy years of retirement, a topic Zero Hedge has discussed in the past.

The full presentation that Stifel used to lure unwitting and naive investors into uber safe CDOs can be found below.

hat tip Richard Sphere: Related Content
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