The ABX and the CMBX have come to be used as external, observable inputs in arriving at fair values of banking assets. For example, in the recent "Sample Letter Sent to Public Companies on MD&A Disclosure Regarding the Application of SFAS 157 (Fair Value Measurements)," the SEC instructed banks to include the following information in their MD&A:
- “To the extent material, a discussion of the extent to which, and how, you used or considered relevant market indices, for example ABX or CMBX, in applying the techniques or models you used to value your material assets or liabilities. Consider describing any material adjustments you made during the reporting period to the fair value of your assets or liabilities based on market indices and your reasons for making those adjustments.”
For example, a profitable investment strategy might have been:
- 1.) short the common stock of banks that are required to mark their assets to market based on the ABX and CMBX indices, and
2.) engage in offsetting "wash trades" of RMBS's or CDO's in an illiquid market at depressed prices, thereby driving down the ABX and CMBX indices.
- "The Federal Energy Regulatory Commission broadened its investigation today into the possible manipulation of energy prices, ordering traders to provide information on whether they engaged in fake trades and whether those transactions affected published electricity prices.
The commission ordered energy traders to disclose whether they had engaged in so-called wash trades, also known as round-trip trades, in which they sell the same amount of power back and forth at the same price. Such sales do not incur profits or losses but allow traders to claim inflated revenue and volumes, potentially misleading investors about the size and liquidity of the market.
In addition, regulators want to know whether traders reported wash trades to publications [similar to the ABX and CMBX] that publish prices for electricity sold around the nation. The published numbers are often used to set prices for financial instruments whose value is determined by the reported prices for the underlying energy commodity."
The SEC should investigate the possibility that the ABX and CMBX have been gamed by “wash trades.”
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