Thursday, July 24, 2008 2 comments ++[ CLICK TO COMMENT ]++

City of Los Angeles Sues Bond Insuers and Investment Banks

Not entirely surprising and I expect many more lawsuits will be filed before all this is said and done. Reuters is reporting that the City of Los Angeles is suing more than 30 bond insurers and investment banks in what seems like an accusation of mass conspiracy to defraud the bond issuers, as well as accusations of bid rigging. The bond insurers are also being accused of violating California's anti-trust laws. It's not clear but I think there are multiple lawsuits being filed, some against the insurers and some against investment banks.

The city of Los Angeles sued more than 30 municipal bond insurers and Wall Street investment banks, accusing them of fraud and antitrust that it said cost taxpayers millions of dollars...

In the complaint against bond insurers, including Ambac Financial, MBIA Inc's MBIA Insurance Corp and Financial Guaranty Investment Co., the city claims it was forced to purchase insurance from a triple-A-rated guarantor in order to benefit from that top rating.

It's interesting that the city is claiming it was forced to buy bond insurance. This is a bizarre accusation given that you can issue bonds without insurance (that's why bond insurance penetration was nowhere near 100%.)

City Attorney Rocky Delgadillo blamed the situation on a "dual credit rating scheme" maintained by bond insurers to take advantage of taxpayers by compelling cities to purchase unnecessary bond insurance.

"Bond insurers' cynical use of this discriminatory credit rating system and inexcusable failure to disclose their high-risk investments in the subprime market also violates California's anti-trust laws and common laws," Delgadillo said in a statement.

It looks like the city is trying to weasle its way out of its committments, while the lawyers make out like bandits. Interestingly, they don't sue the rating agencies.

In the lawsuit filed against Wall Street banks and others involved in investment of the city's bond proceeds, the city accused the firms of colluding to rig the bidding process that was supposed to result in the most competitive rates for the investments, which included guaranteed investment contracts and swaps.

Delgadillo said that as a result, Los Angeles did not obtain competitive rates, losing tens of millions of dollars it should have earned.

Pretty serious accusations but I'm not sure who any of this is going to be proven. I'm not a lawyer but I would imagine that bid rigging should be easy to prove generally, but if you are accusing almost everyone in the industry then such mass conspiracies may be hard to prove.

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2 Response to City of Los Angeles Sues Bond Insuers and Investment Banks

July 24, 2008 at 4:15 PM

When you see a story like this, as an investor, you should look beyond the obvious lawyer-out-to-get-everyone story or the wiggle-out-of-commitmemt angle.

There is a broader angle at play: The mood of the society is changing from positive to negative, from optimistic to austerity. What does this imply in terms the investor perception of value, or to use a favorite term of yours, "intrinic" value? I am not just talking about bond insurers. I am talking about all classes of investments. Also, what does the negative mood imply in terms of people's willingness to borrow and lend? The trust factor? Remember, credit expansion depends critically on trust.

When you are willing to see the big picture, or at least take away your blinders and perform a critical analysis of not just what you perceive, but what others may perceive, THEN you can take a Whitmanesque, Dremanesque, or Your-Main-Man-esque approach to security anaylsis.

This is a sounder way to go than the ludicrous approach of assessing "value" without looking at the big marcoeconomic picture.

July 24, 2008 at 4:37 PM

I actually agree with everything you are said (although your diss of Bill Miller with "main man" doesn't sit well with me ;) .)

Most value investors ignore macro for the most part. However, I personally DO consider the macro stuff (that's one reason I don't consider myself a value investor.)

But the thing is... assets may be cheap even after adjusting for most bearish scenarios. This is especially true for contrarian stocks which are generally beaten up badly and hence have low price (now whether the price is low enough is another story but that's what we try to figure out.)

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