In a typical synthetic CDO deal, an investor will approach an investment bank with specific criteria for the long or short position it wishes to take -- say, a certain vintage mortgage backed security, with a certain rating, and the type of underlying loans. A "reference portfolio" that lists securities matching those criteria is constructed and the bank takes the position opposite the investor's. If an investor wants to be long the reference portfolio, for example, the bank will initially take the short side of the trade by purchasing credit protection from the investor on the portfolio. Often, the bank will then seek out another customer who wants to buy the opposite side of the trade, either simultaneously with the closing of the deal or sometime afterwards.
Both IKB and Paulson & Co made requests for new CDO deals. IKB was a long investor, which meant it wanted to sell credit protection on a reference portfolio. As we reported this weekend, IKB often sought deals offering the highest yields, which meant that they needed to sell protection on portfolios referencing subprime mortgage bonds. Paulson & Co was a short investor, which meant it wanted to buy credit protection on a reference portfolio.
Deutsche Bank's U.S. CDO underwriting group that worked with IKB was co-headed by Michael Lamont, who left the firm in 2008 to work for Seer Capital. When Lamont was reached for comment he wouldn't talk about his trades at Deutsche Bank. Traders who worked with Lamont at Deutsche confirmed he was the point man to sell CDOs to IKB.
Greg Lippmann, head of ABS trading at Deutsche Bank, was also involved in working with hedge fund clients like Paulson who wanted to short the housing market and bet against the CDOs his bank was selling to IKB. Traders we spoke to who worked on an IKB-Paulson deal think the transaction did not violate securities laws and instead were simply offering each client what they were asking for: two different directional bets on the housing market.
"Deutsche's view was: you're all big boys, you do your own research. Here is what's in the security -- you choose if you want it or not. IKB knew exactly what they were buying," said a Deutsche Bank trader who sold CDOs.
Deutsche Bank's head of communications Ted Meyer said he wouldn't comment on specific client transactions. But he did say that the absence of a third party collateral manager distinguished the Deutsche Bank deals from Goldman's Abacus 2007 deal.
"What distinguishes Deutsche Bank's CDO transactions is that both long and short investors were given the opportunity to select the specific collateral to which they were seeking exposure and mutually agreed on the CDO portfolio. No third-party collateral manager was utilized for these deals, which eliminated the potential for deception with respect to the role of such a manager," Meyer said.