Betting against your own side

That same WaPo article, The Crash - What Went Wrong: Frenzy, details a perfect example of a bank using a Credit Default Swap to bet against its own losing assets.

Wachovia had CDOs that were doomed, so it looked for a sucker who would sell it a CDS:

It came up with people like Donald S. Uderitz.

[snip]

Uderitz had once worked for Wachovia. In spring 2007, a Wachovia affiliate approached Uderitz with an attractive offer. The affiliate wanted to buy a kind of insurance from Uderitz's fledging company that would protect the bank against losses on $10 million worth of bonds from a deal called Forge CDO, which Merrill had sold in April 2007. Wachovia would pay Uderitz $275,000 a year for the protection, under a contract that would last until 2053, a healthy stream of income for what was presented as a low-risk transaction. The Forge bonds were rated AA, one step below the highest grade, but still considered unlikely to default.

Wachovia requested that Uderitz post $750,000 to secure his pledge to pay if the bonds defaulted. Wachovia promised to hold it in a separate account and return it once the contract expired. On May 30, Uderitz wired the cash and thought he could sit back and collect more than 40 years of monthly payments.

He thought wrong. On June 18, less than three weeks after signing the documents, Wachovia sent the first of repeated requests for millions in additional collateral, several just a few days apart. One arrived by e-mail on Thanksgiving eve.

Uderitz had already posted nearly $9 million. Now the bank wanted another $550,000. On Thanksgiving morning, Uderitz got up early, put a turkey in the oven and headed to his office to deal with the nightmare. Nearly one-fifth of his investors' money was now frozen in this supposedly low-risk deal.

When Uderitz refused to pony up more cash, Wachovia declared him in default and seized the collateral. Uderitz has since sued Wachovia, alleging that the contract was a sham to "squeeze us out of the trade and steal our money." Wachovia has countersued, seeking the rest of the money that it says is due.

[snip]

Uderitz has a less legalistic view. "They were obviously having some major, major problems," he said. "I think there had to be a conscious shift in their thinking: Go get collateral from whomever we can. We have to save our ass."

Financial judo, courtesy of lax regulation and no transparency.

Nice.