Citi And Bank Of America Snapping Up MBS - Insider Trading?

Few, if any, investors really remember the saga of the Loans to Developing Countries (LDCs) or Highly Leveraged Transactions (HLT). Mr. Timothy Geithner, Secretary of the Treasury, is finishing his plan (somewhat akin to The Brady Plan) to purge the nation’s banks of the toxic mortgage assets -predominately the poster children Citigroup (C) and Bank of America (BAC) in order to get our country’s lending mechanism back on track.

However, these same institutions appear to have found a potential loophole to prop up revenues while utilizing, it would appear, government funds to be in a position benefit from Mr. Geithner’s Public Private Investment Program (PPIC), by aggressively scooping up the same securities in the secondary market.

So far, Citigroup and Bank of America each received $45 billion in Trouble Asset Relief Programs (TARP) funds, which were suppose to have been utilized to prop up the economy and jumpstart the housing market. However, as of late, these banks have been out purchasing what continues to be called “AAA” rated mortgage-backed securities (MBS). These securities are supported by the underlying mortgage as collateral (to include-A and option-ARM as collateral).

Considering that during the current economic crisis the MBS market has been experiencing significant volatility, some investors seem to have begun to bet that a bottom has been reached, as these financial institutions appear to be willing to outbid competing bidders.

As the MBS market has been sparse in recent months, some of these “AAA” securities have been trading at $0.30 on the dollar with yield as high as 22% potentially. While these purchase of secondary-mortgage paper have breathed life back into the moribund securitization market, Bank of America’s rationale is that these MBS purchases increase liquidity in the mortgage market allowing people to buy a home.

In one way, we applaud a company’s willingness to take risks in uncertain times (in chaos there is always significant opportunity). However, to take a more cynical view, this could be a way for these institutions to artificially prop-up the prices of the securities that the PPIC will be in the market to buy.

We would also suspect that these companies have been in talks with both the government and the prospective buyers of their toxic assets and may have observed a “tell.” Either way, the actions would appear to be highly suspect that these institution are potentially gambling with government funds (your and my money) instead of lending as they promised they would.

In addition, we have some concerns that the actions taken by these institutions could potentially have some aspect of insider information/trading illegalities. (Isn’t that what they got Martha Stewart on, after all?)

Here’s another question: If these financial institutions think these are such good investments, why the need for additional government intervention?

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