After slapping charges of fraud on Goldman Sachs, the US market regulator SEC is probing whether other mortgage deals arranged by some of the biggest Wall Street companies misled investors, says a media report.
The Wall Street Journal has reported the regulator is “Investigating whether other mortgage deals arranged by some of Wall Street’s biggest firms may have crossed the line into misleading investors.”
The Securities and Exchange Commission (SEC) filed a lawsuit last on Friday, against Goldman Sachs for defrauding and causing loss of over USD 1 billion to investors by misrepresenting key facts about a financial product tied to sub-prime mortgages.
Noting that the regulator’s case against Goldman Sachs has exposed an open secret on Wall Street, the report said, “As the housing market began to wobble a few years back, some big financial firms designed products aimed at allowing key clients, such as hedge funds, to bet on a sharp housing downturn.”
According to the daily, among the entities that created mortgage deals that soon went sour were Deutsche Bank AG, UBS AG and Merrill Lynch & Co, now owned by Bank of America.
“It isn’t known what deals the SEC is investigating,” the report added.
Going by the report, further cases could depend on whether the regulator sees what it considers misrepresentation and not just questions such as whether a deal favoured one client over another.
At the centre of the scrutiny are instruments called collateralised debt obligations, which are typically backed by bundles of mortgage bonds and other assets.
“In the late stages of the housing boom, some hedge funds that doubted its staying power worked with banks to create CDOs that would provide them with a way to bet against the mortgage market.
“Often the hedge funds bought insurance-like contracts, called credit-default swaps, that would rise in value if the bonds, and thus the CDOs, weakened,” the daily noted.
Soured mortgage investments helped trigger the near-collapse of insurer American International Group (AIG), which had insured at least USD 1 billion of bond deals issued by Wall Street firms in 2005 that reflected hedge funds’ input, the publication said.