More Mortgage Math, Commutations and Morgan Stanley

Shannon Harrington of Bloomberg News published a good article on MBIA CDS recently. (Available here.) Here’s a key quote:

“Swaps traders are speculating that banks are overpaying for default protection as MBIA, based in Armonk, New York, seeks to compel banks to repurchase faulty loans and settles guarantees it made on subprime mortgage-linked securities. Morgan Stanley reported $535 million in losses in the last two quarters from the cost of bond-insurer hedges, including MBIA.”

We don’t know where Shannon gets his information, and this may in fact be third-party market participants moving the CDS. However, we think that given the math we have pointed out regarding commutations, this CDS movement may be due to an unwind. As may have been the movement in October. This may even be Morgan Stanley.

Also of note in the above quote is the losses on hedges against MBIA. There are two key points on this. First, in contradiction to the implications we drew from the 2009 10-K (here), this makes it clear that Morgan Stanley has significant direct hedges on MBIA itself and not just the underlying transactions.

Second, we believe that at least a portion of the $535M losses reference are the actual realization of what we have already pointed out is a first-mover advantage. That is an advantage Morgan Stanley appears to have missed out on, while JP Morgan, Barclays, and some smaller banks captured.

Expect more deals and look forward to March 1st; a tremendous date.