On PacMan partnerships and CDO-squared

Years ago, back in the late 1980s I had occasion to work on some cases related to the failure of The Equity Programs Investment Corporation (EPIC) and a Maryland state-chartered bank called Community Savings and Loan, which was owned by the EPIC holding company, and which also failed in the midst of the S&L crisis.

EPIC was engaged in the formation of tax-sheltered real-estate partnerships. Each partnership owned thirty or so single family homes, and the partnership shares were syndicated to individual high-income investors.

At some point, it became more and more difficult to find investors, so EPIC decided to form new partnerships - called PacMan partnerships - which would buy up the unsold shares of the other partnerships in order to close them out before the tax year ended. Shares of the PacMan partnerships were then sold to the public through syndication, just like the original partnerships.

Somehow yesterday's announcement by MBIA that it had insured a number of CDO-squared investments reminded me of those PacMan partnerships. CDO stands for Collateralized Debt Obligation. In the context of the current credit meltdown, the collateral is usually home mortgages (or portions of the home mortgages). To put it mildly, CDOs are not looking like very attractive investments in today's market -- in fact, you'd be hard-pressed to find a buyer for them. A "CDO-squared" is a CDO the collateral for which is other CDOs. If CDOs are bad investments, you can imagine what CDO-squareds are like.

All of which makes me suspect that there may be CDO-cubed and CDO-to the fourth power investment vehicles out there somewhere. The creativity of these financial engineers is unlimited. So too is their criminality.

As Paul Krugman said the other day, we've struck a fair bargain with the Chinese. They ship us poisoned toys and we ship them fraudulent securities in exchange.

Full disclosure: Unfortunately, I own several hundred shares of MBIA.