Banks are questioning whether Amherst Holdings of Austin, Texas, set them up by selling credit-default swaps and then rendering them worthless. "We wouldn't jeopardise our business and reputation by entering into an opportunistic trade knowing what the outcome would be", said Amherst's chief executive, Sean Dobson.
The burned banks include J.P. Morgan Chase & Co., Royal Bank of Scotland Group PLC and Bank of America Corp. "It's all out warfare" said a senior banker at one firm that lost money. Traders had bought CDS's from Amherst. At least $130 million of bets had been made on the performance of around $27 million in securities.
In April, a servicer called Aurora Loan Services at the behest of Amherst purchased the remaining loans and paid off the bonds, effectively rendering the credit default swaps worthless. Since the mortgage securities were valued at just $3 million or so in the market, well below the $27 million they were redeemed for, traders believe Amherst entered into an uneconomic transaction to profit from it's swap positions.
Critics say such conflicts aren't a surprise, in secretive, over-the-counter markets, that are largely unregulated. Looks like the "too big to fails" failed at taking on one of the little guys!
Disclosure: No position.