Federal Financial Regulations: The Only Way!

Posted on 22. Apr, 2010 by JohnCByrdIII in Business

As Goldman Sachs is being investigated by the Securities and Exchange Commission (SEC) for securities fraud, Obama is busy trying to put together legislation that would give the government more power to regulate the practices of Wall Street that led to the collapse of the economy.  Wall Street has already invested $500 million towards killing Obama’s reform bill.  With the Supreme Court’s decision to legalize bribes, Republicans are counting on big money from Wall Street to fund their campaigns.  Every single Republican in Congress is now on record opposing Wall Street reform.

They claim that this legislation is just another “government take-over” by Obama.  So before you blindly follow the Republican Party into the abyss of ignorance and misinformation propagated by Fox News, please read on to understand what exactly happened to create this economic disaster and you’ll understand why Obama is set on regulating it so that it never happens again!

COLLATERALIZED DEBT OBLIGATIONS

Certain hedge funds, like Magnetar (led by Alec Lidowitz), decided to buy up the majority of the riskiest portions Collateralized Debt Obligations (CDOs) made up of thousands of sub-prime mortgages.  A sub-prime mortgage is a mortgage that is given to a borrower with marginal or poor credit and with low to no income.  These high-risk CDOs are then sold and traded relative to the net value of the loans by the investment banks that created them.

Since hedge firms like Magnetar were purchasing these CDO’s a such a high rate (almost half of the CDOs on the market), the demand for sub-prime mortgages grew.  This means that more lenders would offer “stated” loans where the borrower could just state their income without the burden of proof.

Why would Magnetar purchase such a large amount of high risk debt, you ask?  Three words; Credit Default Swaps.

CREDIT DEFAULT SWAPS

A Credit Default Swap is an insurance policy.  Let’s say that you manage a hedge firm.  You would pay a little money to a Wall Street firm for a particular CDO.  If the CDO does fine, the firm keeps your money.  If it fails, they give you the full value of your CDO.  So in essence Magnetar was placing bets AGAINST CDOs that they helped to create.  What’s most problematic about this is that Magnetar was only purchasing about 1% of the CDO, but insuring the whole package.  So in essence, they were taking $100 million bets on $10 million worth of CDO’s.

Ultimately, hedge firms would stand to make more money if the CDO failed.

EVERYONE’S IN ON IT!

Large hedge firms (like Magnetar) were not the only groups buying in on these very same CDOs.  Many others who did not hold Credit Default Swaps against the loans also owned portions of this debt.  Pensions, mutual funds, education funds and even some personal investors lost millions on these deals.

The most peculiar of these losing investors were investment banks… yes, the very same investment banks that created the CDOs in the first place.  These banks knew that these CDOs were made up of sub-prime mortgages.  They even knew that hedge firms like Magnetar were betting against these same CDOs!

Investment banks like JP Morgan & Goldman Sachs purchased almost 100 times the amount of the CDO than did the hedge firms.  JP Morgan took a $880 million loss in just one of these deals.  I can see you scratching your head.  Why would these investment banks sell high risk loans to themselves, you ask?  They made tens of millions of dollars on each deal in fees.

Here’s how the system of fees works.  Each bank would earn a fee of 1% on each CDO they compile.  So if a Goldman Sachs put a $1 billion CDO together, they would instantly make $10 million.  A large portion of that money would go to senior level executives in the form of bonuses.  Merryl Lynch made over $700 million in CDO fees in 2006 which produced a bonus pool of around $100 million which got divided up amongst at most 80 people.  That’s $1.25 million per executive per year!

In other words, the investment bankers led their investors to believe that these CDOs were good investments even though they knew that they would fail and even knew that hedge firms were betting against them.  Sounds like the plot to Boiler Room.  If the personal investors knew all the information, they wouldn’t have invested and none of this would have ever happened.  This is why Goldman Sachs is in the hot seat now.  The SEC completely missed this whole debacle.

What’s most upsetting is that these same banks are still hounding the victims of this whole situation for mortgage payments, thousands of pensions have been lost, investors lost billions in the stock market, tax payers have bailed out the banks, and the people who made it all happen… get to keep millions of dollars in profit.

As it stands, none of this behavior (no matter how unethical) was illegal.  Obama is trying to make it illegal so that it never happens again.

-The following song puts this whole article in perspective.

The truth is that Wall Street reform will:

-End the bailouts by forcing big financial companies to put aside money now, so if there’s another AIG-like disaster, taxpayers won’t be on the hook. We’ll use the big banks’ own money to shut them down.

-Protect consumers by creating an independent watchdog that would finally stop credit card companies, mortgage brokers, and big banks from hiding information in the fine print.

-Shut down the “shadow markets” by cracking down on the backroom trading that put our economy at risk. Unlike the stock market, these “shadow markets”—where trillions of dollars of “derivatives” are traded each year—are secret, highly risky, and virtually unregulated.

Support Wall Street Regulation!

Tags: CDOs, Collateralized Debt Obligations, corporate bribery, Credit Default Swaps, Financial Regulation, Goldman Sachs, JP Morgan, Obama, Tea Party Politics, Wall Street