M&T Suit Offers Peek into CDO Mess

There's a great story in the New York Times today about how M&T Bank invested $82 million in a Deutsche Bank CDO just moments before the CDO became worthless. The CDO in question, called Gemstone CDO VII, was arranged in several tranches. The tranches M&T bought were rated AAA and AA, respectively. Within the year they had been downgraded several times. The AA tranche was rated CCC-. Ouch. M&T is suing everyone involved (0007064/2008: Supreme Ct., Erie Cty) for fraud, breach of duty, negligent misrepresentation and other claims of the sort employed by them that bought unregistered securities. The complaint (2008 WL 3819736) is a fascinating look at how CDOs were put together and why most of them flew apart immediately.

The incestuous inter-connectedness in the CDO/ABS market is head-spinning. The complaint mentions that quite a bit of the underlying assets in Gemstone weren't mortgage-backed securities - they were credit default swaps written on mortgage-backed securities. Gemstone's criteria for accumulating CDS was the credit rating of the "reference obligation." In other words, the mortgage-backed securities that the CDO wasn't buying. I had a headache before and this isn't making it go away.

Default notice of Gemstone VII

Notice of S&P ratings downgrade