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Pimco's Lehman Losses

Bill Gross of PIMCO participates in a conference on the future of housing finance at the Treasury Department in Washington, DC.
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Bill Gross of PIMCO participates in a conference on the future of housing finance at the Treasury Department in Washington, DC.

So what should investors think about the fact that one of the most trusted bond investment companies made wrong way bets on Lehman Brothers that resulted in billions of dollars in losses?

The Wall Street Journal analyzed recent filingsin the Lehman Brothers bankruptcy case and determined that Pacific Investment Management Co, better known as Pimco, bought billions in Lehman bonds at or near face value in the years and months prior to the Lehman's collapse. After Lehman filed for bankruptcy in September of 2008, Pimco traded Lehman bonds at pennies on the dollar, but any profits from those trades were dwarfed by the losses on the earlier bond purchases, according to the Journal.

An earlier report in the Journal found that Pimco was buying Lehman debt just four days before the bankruptcy, paying $19.6 million to acquire $24.4 million in Lehman debt. And just four months earlier than that, Pimco was actually paying a premium above par to purchase Lehman debt.

It's actually somewhat reassuring that the biggest name in bond investing got Lehman wrong. It shows that the wealthy and the wise do not necessarily have an insight into the world that the rest of us lack. Sometimes they are just as much in the dark as the rest of us.

Several months before Lehman's bankruptcy, in July of 2008, Pimco founder Bill Gross appeared on CNBC and announced there was a 100 percent chance that Lehman would avoid failure. And Pimco put its money where its founder's mouth was.

In many ways, Pimco's Lehman bet was an extreme version of the Pimco view of the world. The company seems to assume that the world operates in an orderly—almost predictable—way. If the Fed is buying Treasuries, Pimco buys Treasuries. If the Fed announces it is getting out, Pimco gets out. If there's a sell-off in muni bonds based on fears of never-before realized defaults, Pimco comes into the market to tell everyone to calm down.

In short, Pimco resembles a global arbitrage firm. When things get out of whack, it's best that they'll get back into whack soon enough.

With Lehman, that didn't happen. Things got out of whack and stayed that way. Pimco just wasn't prepared for a world of out of wackiness.

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