The Securities and Exchange Commission (SEC) proposed on Monday that financial institutions either underwriting or sponsoring asset-backed securities (ABS) be restricted from making profits out of the losses of investors for one year. The SEC proposal is in the interest of investors who were losing their hard earned money due to the ABS originators’ bets on bundled financial products.
Earlier this year, U.S. Senate investigators raised issues accusing Goldman Sachs (GS) of earning profits from clients’ losses on complex financial products sold by them. Goldman used to create and market a collateralized debt obligation known as ABACUS 2007-AC1, hiding from investors the fact that the underlying securities were selected by hedge fund Paulson & Co, which was betting against them. However, Goldman settled the SEC accusation for $550 million.
The latest proposal by SEC is expected to address the cases like Goldman’s by outlawing third parties from selecting underlying securities of an ABS.
The SEC’s proposal would implement a provision in the Dodd-Frank Act, which significantly overhauled the U.S. financial system after the near collapse of Wall Street during the 2007–2010 recession.
The banning bid is also akin to the aims of the Volcker Rule. Named after Paul Volcker, a former Federal Reserve chairman who advises the Obama administration, the Volcker Rule was designed to restrict types of risky investments including proprietary trading and private equity investments that triggered the financial crisis. The primary intension of both the SEC proposal and the Volcker Rule is to keep the risky bets that banks play with investors’ money in check.
The latest buzz surrounding the controversial Volcker Rule that restricts proprietary trading of U.S. banks is that it might stretch to foreign banks, such as Deutsche Bank AG (DB) and Credit Suisse Group (CS), with operations in the country.
Though the restrictions under the Volcker Rule are yet to be finalized, many big U.S. banks including Goldman Sachs, Citigroup Inc. (C) and Bank of America Corp. (BAC) have already started responding in its favor. These banks continue to shed their proprietary trading operations.
According to some industry executives, the strict restrictions imposed by the SEC could hamper the recovery of the securitization market. However, we think it’s more important to significantly rationalize the risky activities taken by financial institutions that went on to become the key culprits of the latest meltdown. Also, as the restrictions will not be applicable when a firm is hedging its risk or acting as a market-maker, the impact on the recovery of securitization market will be mild.
BANK OF AMER CP (BAC): Free Stock Analysis Report
CITIGROUP INC (C): Free Stock Analysis Report
CREDIT SUISSE (CS): Free Stock Analysis Report
DEUTSCHE BK AG (DB): Free Stock Analysis Report
GOLDMAN SACHS (GS): Free Stock Analysis Report
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