Source: This is London

Texan broking firm Amherst Holdings is said by the Wall Street Journal to have forced big banks into losses of tens of millions of dollars when they believed they were on to sure-fire profits.

The trade involved $29 million (£17.6 million) of securities that were backed by subprime mortgages. The big banks believed that these were almost worthless and so bought credit-default swaps based on them. These effectively act like an insurance policy paying out if the securities become worthless.

Traders for JPMorgan are reported to have paid between 80 cents and 90 cents in the dollar forthe credit-default swaps betting that they would get a dollar back. Royal Bank of Scotland andBank of America also bought some of the credit-default swaps. Up to $130 million of bets weretaken against the original $29 million of securities.

But somehow Amherst engineered that the underlying loans were paid off and the bonds repaid. Thatmade the insurance worthless and all bets were off.

Read more: http://www.thisislondon.co.uk/standard-bus...

---

Amherst Holdings took recognized the same flaw with the "naked" credit default swaps that I have been discussing here for months: If the underlying loans are paid in full (think of it as a special version of refinancing with paying off at 100% the original loan), then the value of ALL the related swaps goes to zero!

I had been pushing that as a way to limit the risk to the gov/taxpayers to that of the bad loans "once" rather than multiple times making good through AIG on the bets involving swaps.

Amherst Holdings found a way to make money off this issue.

(This was first reported by WSJ, but their article is still behind the login.)