How American snake oil sellers cheated innocent australian investors

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Ruing CDOs Down Under
Australian Beach Suburb
Discovers Its Exposure
To U.S. Subprime Woes
By JACKIE RANGE
October 4, 2007

SYDNEY, Australia -- At a recent meeting of the Manly Council, which governs
a beachfront Sydney suburb, topics included Meals on Wheels, an antismoking
policy for outdoor areas and U.S. subprime mortgages.

Earlier this year, the council handed 5.5 million Australian dollars (US$4.9
million) to Grange Securities, a small Australian investment bank. Council
staffers were taken with the idea of slightly higher returns that Grange
representatives proffered. They also were put at ease by Grange's client
list, which includes dozens of Australian councils.

Grange was "quite firm and quite positive about the fact that they thought
they could do a bit better than what we were doing ourselves," says Jenny
Nascimento, manager of finance operations at Manly Council.

Now, Manly is ruing its investment decision, as are many councils across
Australia. Manly officials say A$3 million of the money the council gave
Grange was invested in collateralized debt obligations -- bonds underpinned
by large pools of debt, including, in one case, U.S. subprime mortgages. As
of Aug. 31, Manly was facing a paper loss of A$588,767 on the money it gave
to Grange, funds that were collected from residential and business taxes,
and charges for sporting facilities and parking, among other things.

"All of the client base are recognized as sophisticated investors who are
responsible for their own due diligence relating to their investment
decisions," a Grange spokesman said. "However, we do spend a great deal of
time explaining the investments to our clients and ensuring all risks, etc.,
are clearly outlined in the documentation."

Initially, CDOs and other mortgage-backed securities were almost solely in
the purview of investment banks and hedge funds. As these sophisticated
buyers became saturated and the U.S. housing boom of the past several years
kept delivering vast quantities of mortgages, the banks that created CDOs
and other mortgage securities looked further afield for potential buyers to
sop up the supply. Last year, banks issued $388 billion of all types of CDOs
world-wide, up from $52 billion in 1999, according to Dealogic, a
data-research firm.

They found a willing audience among town councils, small governments,
charities, conservative state-run banks and risk-averse individual
investors. Most of them were outside the U.S. and many had just a few
million dollars, at most, to invest.

CDOs were appealing to many of these average investors because they promised
to add a dash of juice to their investment portfolios. Although CDOs often
are portrayed as complex and risky derivatives that offer huge returns, in
many cases they offer an interest rate just a smidgen above government
securities or a savings account, but supposedly with no more risk.

SachsenLB, a conservative state-run bank in Germany, was so enamored with
mortgage securities that it set up an operation to trade mortgage securities
and handle other investments from an office in Dublin. Bank of China Ltd., a
big state lender, said its exposure to U.S. subprime mortgages stood at
$9.65 billion. In the U.S., by comparison, the take-up among conservative
investors looks relatively small.

The CDOs that washed up on Manly's tree-lined beaches were selected by
Grange, which has since been bought by Wall Street brokerage Lehman Brothers
Holdings Inc. The firm distributed its first CDO in 2002. Grange negotiated
with investment banks such as Lehman or Barclays PLC of the United Kingdom
to tailor products for its conservative client base, people close to Lehman
said. "We saw an opportunity and, indeed, a need from an investor base to
get advisory services and have access to the broader fixed-income market,"
said Glenn Willis, Grange's country head.

By August 2005, there were A$5.7 billion of publicly offered Australian CDOs
outstanding, according to an Australian central-bank report. Since 2002,
roughly 65% of Australian CDOs were bought by such investors as local
governments or charity endowments.

Manly is part upscale Sydney suburb and part beach town. Many of its
residents enjoy one of the world's most stunning commutes, riding ferries
across Sydney Harbor, past the famous Sydney Opera House, to get to work.

The town, which invested a sum equivalent to roughly 10% of its annual
operating budget with Grange, now is counting its losses. Manly saw the
value of its investment in one CDO called Federation plummet to A$172,310 as
of Aug. 31, from its original investment value of A$500,000.

Many other Australian councils face the same predicament and must decide
whether to suffer the losses now or hang onto securities that face an
uncertain future. "We're good at local government, but we're not necessarily
good at investment," said Ross Fleming, Manly's chief financial officer.

Three councils say Grange put them into CDOs that were outside their
criteria for investments or contained other irregularities, according to
people familiar with the matter. For instance, the CDO called Federation is
due to mature in 2047, exceeding the 10-year limit for the Woollahra
Council, another Sydney suburb, to hold any security.

Grange has paid at least several million dollars in reimbursements to
councils, council officials say. They declined to comment on why the money
had been paid, citing confidentiality agreements with Grange. Woollahra
Council, for instance, demanded the Federation security be bought back, and
Grange complied, said Tony Lewis, managing director of Lewis Securities
Ltd., who acted as an independent adviser to the council.

Grange declined to comment on individual clients. A spokesman said that the
firm has "canceled trades" in a limited number of instances and that it
"engaged in appropriate selling practices in the distribution of its
products to clients." People close to Lehman note that more than 90% of
Grange's CDOs have performed well so far.

Another gripe was that some of its CDOs, which contained U.S. and European
assets, had Australian names, such as Kalgoorlie (a western Australian
mining town famous for gold, nickel and brothels).

These labels disguised the true nature of the investments, some say. "I will
make the conclusion that they were trying to mislead us, by giving
Australian names to U.S. assets; you can draw your own conclusion," said
Councillor Andrew Petrie in Woollahra, which owned Kalgoorlie. "If they'd
been called 'Detroit,' you'd have said, 'What's this?' "

The Grange spokesman said the securities were denominated in Australian
dollars and had other Australian characteristics. Market participants said
it wasn't unusual for such securities to have Australian names.

--Carrick Mollenkamp in London, Craig Karmin in New York and Rebecca Thurlow
in Sydney contributed to this article.

Write to Jackie Range at jackie.range@dowjones.com
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