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May 12, 2010 1:04 am
Morgan Stanley has entered into arbitration talks in London with a failed hedge fund that claims Wall Street banks contributed to its collapse by undervaluing its collateral during the financial crisis, according to people familiar with the matter.
The talks between Morgan Stanley and the Basis Yield Alpha Fund, which was liquidated in 2007, highlight the continuing disputes over how to value the complex securities, such as collateralised debt obligations, that figured prominently in the crisis.
Basis said CDOs it posted as collateral were liquidated by Morgan Stanley and other banks at artificially low values.
This liquidation occurred after the hedge fund was unable to meet margin calls on the CDOs, which it bought using a mixture of cash and bank financing in the summer of 2007.
An expert witness for Basis has testified that Morgan Stanley valued the Basis positions – which had a notional value of $100m – at between $10m and $12m less than they were worth, people familiar with the matter said.
The CDOs were mostly backed by pools of subprime mortgages.
Morgan Stanley declined to comment.
Basis has also claimed that Citigroup undervalued CDOs it posted as collateral. After talks between the two parties, the amount of money Basis owed Citigroup at the time of its collapse was reduced by several million dollars, people familiar with the matter said. Citigroup declined to comment.
Goldman officials privately disparaged the Timberwolf CDO in e-mails released by Senate investigators. Goldman declined to comment on the Basis matter.
Last month, the Securities and Exchange Commission filed civil fraud charges against Goldman and one of its executives, Fabrice Tourre, alleging they misrepresented the role played by a hedge fund in creating another CDO underwritten by the bank known as Abacus.
Goldman Sachs and Mr Tourre have denied any wrongdoing.
In an e-mail released before Senate hearings into the matter, Mr Tourre was quoted as referring to CDOs, in general, as “a ‘thing’ which has no purpose, which is absolutely conceptual and highly theoretical and nobody knows how to price”.
Even surviving hedge fund counterparties of Wall Street banks have claimed that when they have posted CDOs as collateral, banks have been overly aggressive in marking down the value of the securities.
Hedge funds typically buy securities using financing from Wall Street banks.
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