Is The SEC Unfairly Using Reputation Risk To Pressure Goldman To Settle?

News outlets, New York Times, Bloomberg, etc., are reporting that Goldman Sachs is under criminal investigation by the US Attorney for mortgage trading fraud. Goldman's shares dropped over 9 percent today on the news and about 25 percent since its peak about 6 months ago and prior to the SEC's announcement of its investigation into the ACA Paulson Abacus deal.

It is not at all surprising that the SEC referred the Goldman case for criminal review. The SEC often refers civil cases to the Justice Department for criminal review and it is not at all surprising that the SEC referred this high visibility case with populist appeal to the US Attorney for criminal review. It makes the SEC's case look stronger and criminal charges would make it easier to settle the case with Goldman.

Goldman's risk of losing to the government on the criminal or civil case is not high. Many SEC criminal referrals quietly disappear without charges against the firms. Goldman's greatest risks right now are its reputation and lost business.

My impression is that the price drop in its shares is not due to fact that Goldman is under criminal investigation. A criminal referral is expected. The share price dropped because the information is now in the public media.

The government does not announce criminal investigations and waits until an indictment to issue a press release. The government appears to have leaked the information about the investigation directly to the press or to parties with contacts with the press as a strategy to win this case.

Many entities will not do business with a firm under possible criminal indictment and the news stories will make many entities aware of the criminal investigations and make it harder for them to avoid acting upon the news and stop doing business with Goldman.

It appears the government is using reputation risk, lost business, and an Arthur Anderson scenario to pressure Goldman to settle with the SEC and admit guilt.

Revised Bank Secrecy Act Anti-Money Laundering Examination Manual Released

Just a few years ago, during the height of the housing bubble, the major issue facing the banks and bank regulators was anti-money laundering. Large fines were levied against Riggs, AmSouth, Arab Bank, Union Bank of California and Wachovia. As usual, there were Congressional hearings and concerns about regulatory oversight.

Today, the Federal Financial Institutions Examination Council (FFIEC) released the revised Bank Secrecy Act/Anti-Money Laundering (BSA/AML) Examination Manual.

Now the hearings are about the financial crisis and, guess what else, regulatory oversight.

US Presidents Foreign Sources Oil Percentage

From "Foreign Oil Dependency by U.S. Presidential Exhortation" By Paul Kedrosky.

Goldman's Senate Testimony Was Not Laughable Or Obscene

The following is a comment I posted on "Making markets" by Mark Crosby on Core Economics Blog:

Goldman's testimony about market making is neither obscene nor laughable. I do not see the import of Goldman's view of the product. On one side, a party asks Goldman for an investment product with a yield higher than US treasuries and with a good credit agency rating. On the other side, the party asks for a product that is inversely linked (shortable) to high-risk residential mortgages. In between the two parties is Abacus Synthetic CDO. Both parties at the time of investment got what they wanted. Yes, at times the market maker is approached by one side of a transaction and has to find and sell the other side to complete a deal. No one forced IKB, ACA and others to buy into the deal. A salesperson called investors likely to be interested, described the product as all salespersons describe products, and they took the long side. They invested. Market makers are not investment advisers. The investing firms have their own analytical ability. Goldman is an intermediary, a finder, a matchmaker.

There were only 90 mortgages in the synthetic CDO. Did any long investor ask for the credit scores or geographical locations of the homes? Did any investor analysts look at available data for residential mortgage default rates in the areas of the homes?

Suppose a restaurant customer asks the chef to heavily salt, overcook (extremely well done, crispy, burnt), and add lots of Tabasco sauce to hide the flavor of the chef's specialty fish dish. When served, the customer says it is exactly what he wanted. Is it important to know that the chef in the kitchen says the dish will be crap and he would not eat it? Suppose the chef thinks pasta is best al dente and lightly sauced but many customers complain and ask for over cooked pasta that is drowned in sauce, and the restaurant regularly serves the pasta heavily sauced and overcooked to attract customers and make money. Who cares if the chef would not eat it that way?

A market maker matches a long investor with a short investor. It is impossible for the market maker to agree with both parties' opposite investment outlooks. If the product is crap for one side, it is a great investment for the other side. Sometimes, the quantities on both sides do not match and the intermediary, the market maker, takes a position so the both sides of the transaction can be completed. Furthermore, the risk management part of the company might short the same instruments because it is aware that the firm tends to hold long positions as part of transactions.

Suppose Goldman instead of saying the deal was crap, say it was great for the long investors and it bought long positions for itself. Did Goldman then deceive Paulson for whom it created the synthetic CDO?

Either Goldman deceived Paulson or ACA and IKB by your point of view. Market makers are in the middle, match longs and shorts and do not deceive either party, no matter what the market maker's point of view of the transaction is.

Regulators Increase Systemic Risk: Comment to "Great Moments in Financial Regulation"

A comment I wrote to the Wall Street Journal article, "Great Moments in Financial Regulation: Apple IPO deemed too risky" by Paul Atkins:

"Markets froze in the fall of 2008 because no one could be sure of the financial condition of financial institutions and their counterparties. For all the government's extraordinary intervention, the markets showed their greatest improvement after the Fed's imperfect stress tests were made public in early 2009."

It was not uncertainty about the condition of the financial institutions that caused the markets to crash. It was the uncertainty about government intervention that created the mess. The Government arbitrarily backstopped Bear but not Lehman. Unlike with the investment banks, the government can step in and takeover commercial banks at anytime by declaring them unsound.

Investors did not know or understand the government's game plan (if there was any at all) for dealing with the housing crisis effects on bank asset values and whether the banks were going concerns or going out of business concerns. Was the government going to close large banks or keep them open? What was the status of uninsured creditors and collateralized lenders? The private sector did not know or understand what contractual rights it had with troubled banks and companies, or whether the government would shut them down or allow them to continue.

Passing the stress test, even though it was a charade for the most part, meant the government was going to leave those banks alone. The markets began to breathe again because investors understood the government was backing away.

The markets froze in response to the government's action, not because the government was inactive, did too little or was ineffectual. Once the stress tests clarified that the government was done meddling in the banks, the markets began to clam calm down. The stress tests revealed more about the likelihood of future government action than it did about the condition of the banks. The stress tests added clarity to future government action; not clarity to the banks' balance sheets.

The Dodd bill will increase systemic risks and market failures because it will give more power and discretion to the regulators to act against financial institutions. Powers that allow government intervention in markets and financial institutions increase systemic risks exactly because regulators do not act as investors or perceive risk the same way investors and other market participants perceive risk. Government and regulators are an additional, unpredictable, non-diversifiable risk that restricts investors' options during a financial crisis.

When regulators intervene, investors lose the value of their investments in the financial institution. Since the financial crisis, all corporate bondholders, not just GM's and Chrysler's, mortgage lenders, and collateralized lenders face more systemic risk than before the crisis.

Giving more financial regulatory power to government will spread and increase the systemic risk in the financial sector. It will not lower systemic risk.

[See my previous post, "Obama's New Bank Restrictions Increase Systemic Risk: The VIX Rose 19 Percent"]

Goldman Sachs Wells Submissions

I am posting links (via the Wall Street Journal server) to copies of Goldman Sachs Wells Submission and Wells Supplement Submission to the SEC's Wells Notice.

The links are also available in the sidebar to this blog.

The crux of Goldman's case is that the parties knew or were aware of all material information and that Paulson was a relatively unknown person at the time and immaterial information.

(HT: Mark J. Astarita, Esq. of the SECLaw.com Securities Law Blog).

Earnings Decline After Losing A Job During A Recession

Earnings After Involuntary Job Loss:
In both the short and the long term, people who lose a job for reasons other than poor performance or misconduct and then find a new job see their earnings decline, on average. Short-term declines in earnings—those in the first few years after a job loss—tend to be larger for people who lose a job during or shortly after a recession....

For people who have acquired a substantial amount of firm-specific knowledge, the loss of a job can be associated with a relatively large decline in earnings in the short term.

From CBO Report: "Losing A Job During A Recession." Also available for download here.
Losing a Job During a Recession: CBO

Embedded Copies Of Senate And House Financial Reform Bills

Embedded copies of Senate and House Financial reform bills, S3217, Restoring American Financial Stability Act of 2010 and HR4173, Wall Street Reform and Consumer Protection Act of 2009. The Senate bill is also known as Sen. Dodd's bill and the House bill is also know as Barney Frank's bill.

Senate Financial Reform S3217

House Financial Reform HR4173

Texts Of House And Senate Financial Reform Bills

Text of Senator Chris Dodd's financial reform bill, S3217, "Restoring American Financial Stability Act of 2010."

Summary text of Senate financial reform bill as filed.

Committee Report for S3217.

Text of Representative Barney Frank's financial reform bill, HR4173, "Wall Street Reform and Consumer Protection Act of 2009" as referred to the Senate and passed by the House.

Comment I Posted To "Did Goldman deceive...?" On The Conglomerate Blog

Comment I posted on the Conglomerate Blog, "Did Goldman deceive the collateral manager? Why it matters" by Erik Gerding.

I think the case is more complicated. The CDO is synthetic and, by definition, will include various derivatives (CDSs and other forms of derivatives). All derivatives are zero sum and have counter parties. The derivatives in use here are bespoke or not standardized, exchange traded derivatives. All the parties understood these facts.

The long investors, IKB, ACA and any other investor understood that there was a counter party to the derivatives with economic interests adverse to their interest. If there was not, the derivatives could not exist.

In non-standard, non-exchange traded derivatives, both sides to the derivative have input and negotiate the terms.

All the long investors understood that there was a short party(ies) to the transaction negotiating pricing and terms including the mortgages to be included. While it is not in the complaint, it is safe to assume that ACA (and the other investors) understood a party economically adverse to the long side of the transaction was suggesting mortgages. ACA is an experienced party to this type of transaction.

Since ACA understood there was an adverse party suggesting mortgages, is it relevant or material if it is Paulson? I think not unless you believe Paulson used fraud, undue influence or coercion to get ACA to accept a mortgage. The facts in the complaint do not support this since, ACA rejected some of the mortgages suggested by Paulson and ACA suggested mortgages not on Paulson's list that Paulson and the other parties accepted.

Is The Goldman Sachs Case Mary Schapiro's Waterloo?

Despite the anger and the populist sentiment against the investment banks and a general populace belief that the banks caused the housing bust, the banking crisis and the economic recession, many knowledgeable attorneys, based on the facts as presented by the SEC in its civil complaint against Goldman Sachs, believe that Goldman Sachs did not violate any existing securities laws.

Unfortunately, SEC Chairman Mary Schapiro's timing looks political despite claims of denial by the White House and the SEC. The SEC filed its case against Goldman just before Congress began consideration of financial reform legislation and as President Obama pushed financial reform as a priority. Additionally, she was the deciding 3-2 vote to bring the case against Goldman.

Goldman Sachs is looking to rid itself of this case as soon as possible to protect its remaining reputation and to put a chill on other governmental investigations and investor lawsuits.

Settlement at this point is out of the question. The SEC will extract too high a price from Goldman. One of Goldman's options is to ask the court to either dismiss the case or grant summary judgment. Goldman will almost certainly file court motions for dismissal or summary judgment. It is just a matter of when.

If the court grants either a dismissal or summary judgment in Goldman's favor, it will make the SEC look even more politically motivated in bringing the case then it does now. It will be another major embarrassment for the SEC, along with the embarrassing settlement attempt with Bank of America over the Merrill Lynch deal, and the Madoff and Stanford scandals. Major changes will be called for at the SEC including a call for a new SEC Chairman.

Mary Schapiro is a loyal public servant with years of service at the SEC, the CFTC, NASD and FINRA. The Goldman Sachs case could turn out to be the end of Mary Schapiro's career at the SEC and possibly in government service. In being a loyal public servant in a populist administration, she may have put her career on the line in being the SEC Chairman and the deciding vote to bring an extremely weak case against Goldman Sachs.

Comment On Bankruptcy Reform Will Limit Bailouts Article In Wall St. Journal

A comment I posted to the Wall Street Journal article, "Bankruptcy Reform Will Limit Bailouts" by Thomas Jackson And David Skeel.

This is an old issue. The 1982 revision to the Bankruptcy code put in place exemptions for derivative contracts from the automatic stay provisions of Bankruptcy law. The automatic stay of filing for bankruptcy gives a firm time. It means a firm does not have to pay its debts immediately. The exemption to the stay means that going into bankruptcy does not prevent a firm from having to pay its derivative debts immediately even while it is in bankruptcy proceedings.

At least two professors, Columbia Business School Prof Franklin R. Edwards and Columbia Law School Prof Edward R. Morrison believe this provision increased the systemic risk of the Long Term Capital Management hedge fund collapse in 1998 and created the need for the Federal Reserve to step in after LTCM suffered investment losses.

See their 2005 paper, "Derivatives and the Bankruptcy Code: Why the Special Treatment?" at:
https://www0.gsb.columbia.edu/faculty/fedwards/papers/Morrison%20&%20Edwards%20Yale%20Rev%20final.pdf

It is ironic because the derivative exemptions to the bankruptcy stay were added to do just the opposite and decrease systemic risk.

House Congressional Democrats 2010 Reelection Chances Hurt By Goldman Charges

Surprisingly, the Democrats chances of maintaining control of the US House of Representatives declined from Friday to Monday after the SEC charges against Goldman Sachs were announced. The Intrade share price dropped 6 points from 56 to 50 on Monday and dropped another 3.2 points to 46.8 as of close of trading on Tuesday, April 20. The decline from 56 to 46.8 is a loss of almost 16.5 percent.

Following is the Intrade security for 2010 US House of Representatives Control as of close April 20, 2010:

The Democrats to control the House of Representatives after 2010 Congressional Elections:

Following is the Intrade security for 2010 US House of Representatives Control as of close April 20, 2010:

The Republicans to control the House of Representatives after 2010 Congressional Elections:

The Republicans chances of gaining control of the US House of Representatives increased from Friday to Monday after the SEC charges against Goldman Sachs were announced. The Intrade share price rose 3.2 points from 46.8 to 50 on Monday and rose to 50.3 as of close of trading on Tuesday, April 20. The increase from 46.8 to 50.3 is an increase of almost 7.5 percent.

Goldman's Abacus 2007 AC1 Flipbook

The Goldman Sachs Abacus Flipbook is no long available at the below article link, but is available on the NYU faculty webpage of Marco Avellaneda, Professor of Mathematics, Courant Institute of Mathematical Sciences, New York University at http://www.math.nyu.edu/faculty/avellane/ABACUS.pdf

Goldman Sach's Abacus 2007 AC1 Flipbook (from ritholtz, aka Barry Ritholtz of The Big Picture blog). It contains information about the synthetic CDO that is the basis of the SEC fraud complaint against Goldman Sachs:
30036962-Abacus-2007-AC1-Flipbook-20070226
The Goldman Sachs Abacus Flipbook is no longer available at the above link, but is available on the NYU faculty webpage of Marco Avellaneda, Professor of Mathematics, Courant Institute of Mathematical Sciences, New York University at http://www.math.nyu.edu/faculty/avellane/ABACUS.pdf

Another Comment On Goldman Vs SEC

Another comment I wrote to a Wall Street Journal article, "The SEC vs. Goldman: More a case of hindsight bias than financial villainy."

Goldman could have structured the whole deal and allowed Paulson to both own the equity position and short at the same time. Paulson would only have had to increase his short position to offset the addition of the equity portion. The fact that that there is no need to go through a charade of Paulson taking equity when he could have taken a real equity position to perpetrate the fraud, shows that no one was trying to perpetrate a fraud on the investors.

The WSJ opinion piece is correct that this appears to be nothing but a political play by Obama to get his financial reform passed.

The fact that the SEC asked Goldman in 2008 for info on this deal does not clear the SEC of politics. The SEC often asks Wall St firms for additional info about deals and securities. The SEC went to its file and found this older info inquiry about CDOs to make it appear non-political.

Emails from employees that the sky is falling are also irrelevant. Who has not worked in a company and heard the employees say the firm does not know what it is doing, or that it is ripping off customers, or if the customers only knew. It is normal office talk among cohorts, who think they know more than their bosses and everyone else. Many times the employees are just reflecting their own job frustrations.

Comment On Sec Challenges With Materiality Of Goldman Charges

A comment I posted to a Wall Street Journal article, "SEC Faces Challenges With Goldman Case" by Kara Scannell:

As a first step, the SEC will have to show that Paulson's involvement and shorting was material information to investors. I do not see it.

Paulson had no control or non-public information about the individual default rates of the mortgages. His involvement was to suggest more mortgages in the few states with the biggest housing bubble and with borrowers with lower fico scores. The mortgages in the pool and the selection criteria are disclosed in the offering documents. Furthermore, there is nothing to indicate that ACA did not have a final say about mortgage inclusion as the independent adviser.

Sophisticated investors at the time knew generally, that Paulson was shorting the residential mortgage market, as were other investors. Paulson's shorting did not begin with this offering and he had lost money shorting during the earlier stages of the housing bubble.

The fact that Paulson asked for Goldman to put together a portfolio to short against is not material. The fact that Paulson asked for more mortgages in bubble states with high risk borrowers is also not material since the mortgages are disclosed in the offering documents and by definition subprime mortgages are high risk borrowers and most likely in hot real estate bubble markets.

In fact, given Paulson's poor track record in shorting at the time, knowledge of his involvement probably would have led to more interest in the portfolio than less.

Paulson's involvement and shorting does not change the risk or expected returns of investing in subprime mortgages and the mortgages were fully disclosed by Goldman.

Investors who invested in the Goldman portfolio would have done so at the time even knowing Paulson was shorting it and asked for its creation.

Remember, all the parties involved were questioned by the SEC after they had all lost money investing in subprimes. Of course, they are going to say it was not their fault and Goldman misled them by not telling them of Paulson's involvement. They are just trying to protect their reputations by saying it was Goldman's fault.

This case will never go to trial. A judge will dismiss the complaint as a matter of law for a lack of materiality.

Comment On Goldman Sachs' SEC Complaint

The following is a comment I posted to the Wall Street Journal article, "Goldman Is Charged With Subprime Fraud" by Joe Bel Bruno, Fawn Johnson and Joseph Checkler:

Paulson & Co did not engage in any fraud. Shorting is a legal activity, even when one knows another party is long securities. It is also legal to submit requests of securities to include in a portfolio. There is often a give and take between institutional investors and underwriters about structure, portfolio and pricing so that the underwriting sells and meets the needs of the buyers.

There is no claim in the SEC complaint that the securities in the portfolio were misrepresented or that the portfolio was not as described. Saying that they were mostly from a few states and low fico scores is irrelevant because those were the states with the hottest home markets and all mortgage portfolios were heavy in those mortgages. If it were not the case, only this portfolio would have collapsed, but just about all subprime portfolios from all underwriters from the same time period lost most, if not all their value.

ACA was hired to select the portfolio and was named in the offering documents. The SEC is saying that Paulson influenced ACA's MBS selections and that Goldman should have disclosed Paulson's involvement and his short interest.

Even if ACA was influenced by Paulson, it is unclear Goldman had any duty to inform investors that Paulson & Co was involved or that it t had an effective short interest in those securities. ACA was not forced or coerced to accept Paulson's recommendations and could have objected to specific securities to include in the portfolio or removed itself from the underwriting.

ACA either agreed with Paulson's assessments or was completely negligent is accepting them. ACA and not Goldman may be at fault here but the SEC cannot sue ACA for a bad analysis or for outsourcing the analysis to Paulson.

The SEC will have to show that Goldman intended to defraud investors and set ACA up as a front to hide Paulson's involvement. It does that appear to be the case.

With or without Paulson's involvement, the offering would have lost a lot of its value shortly after issuance due to the collapse of the subprime mortgage and housing markets.

ACA seems to be covering itself and rewriting history to make it appear the subsequent portfolio losses were not due to its poor analytical ability to assess MBS and CDOs.

As often happens, after a risky investment loses a lot of its value, the SEC sues. Lawyers and SEC personnel do no understand risky investments and that risky investments can lose most or all their value without any fraud by the underwriter.

The issue is not that the investments lost most of their value. The issue is Paulson's involvement and whether Goldman had a duty to disclose Paulson's activity with ACA.

SEC's Civil Complaint Against Goldman Sachs For Securities Fraud

SEC's civil complaint against Goldman Sachs for securities fraud in underwriting a [synthetic] mortgage backed security (MBS) collateralize debt obligation (CDO) of subprime mortgages in early 2007. Specifically, Goldman failed to disclose Paulson & Co. was actively involved in selecting the mortgage portfolio while effectively holding a short position in the same mortgage portfolio through a credit default swap:
SEC Complaint - Goldman Sachs

Obama And Biden 2010 Income Tax Returns For 2009 Taxable Year

President Obama and Vice President Biden released their 2010 tax returns for the 2009 taxable year.

The Obama's reported an adjusted gross income of $5,505,409 and paid $1,792,414 in federal taxes. They paid $163,303 in Illinois state income taxes.

The Biden's reported an adjusted gross income of $333,182 and paid $71,147 in federal income taxes for 2009. They paid $12,420 in Delaware income taxes and $1,477 in Virginia income taxes.

The president's and Vice President's 2009 tax returns filed April 2010 are embedded below.

Obama and Biden taxable year 2010 tax returns filed April 2011 are available here.

President Obama's 2010 tax return for 2009 taxable year:
President Obama 2010 Complete Tax Return

Vice President Biden's 2010 tax return for 2009 taxable year:
VP Biden 2010 Complete Return For 2009 Taxable Year

Cutting Funding For Education Without Negatively Affecting Student Outcomes

Despite the more than double per pupil expenditure of inflation adjusted tax dollars on k-12 education from 1970 to 2005, there has been little, if any, improvement in student outcomes. Reading, Math levels and high school graduation rates have remained flat and unaffected by the increase in education expenditures.

The above chart is from the September 2008, Heritage Foundation report "Does Spending More on Education Improve Academic Achievement?"

The above chart is from the 2002, Hoover Institution report "Can Money Buy Better Schools?"

The obvious question, during these very difficult fiscal times of state and local finances and large federal budget deficits, is can we significantly cut k-12 per pupil expenditures without negatively affecting student outcomes?

If we can double per pupil outlays without positive impacts on student educational results, can we substantially reduce our education expenses, maybe by even half, without reducing student reading and math scores and without reducing high school graduation rates?

It seems likely.

See also the following, among many others, consistent studies of the lack of any positive relationship between per pupil education outlays and student outcomes, "Spending Increases Don't Improve Student Achievement: Report" and "PUBLIC SCHOOL SPENDING AND STUDENT ACHIEVEMENT: THE CASE OF NEW JERSEY."

CBO Discusses Limtations And Challenges Of Health Care Budgetary Estimates

Congressional Budget Office Presentation to the World Health Care Congress, "The Effects Of Health Reform on the Federal Budget" on April 12, 2010 by Douglas W. Elmendorf, Director, CBO.

The Effects Of Health Reform on the Federal Budget

Federal Regulators Faulted For Poor Bank Supervison

Regulators failed for years to properly supervise the giant savings and loan Washington Mutual, even as the company wobbled under the weight of risky subprime mortgages, a federal investigation has concluded.

The two agencies that oversaw Washington Mutual, the investigation found, feuded so much that they could not even agree to deem the company “unsafe and unsound” until Sept. 18, 2008.

By then, it was too late. A week later, amid a wave of deposit withdrawals, the government seized the bank and sold it to JPMorgan Chase for $1.9 billion. It was by far the largest bank failure in American history.

From "U.S. Faults Regulators Over a Bank" by Sewell Chan in The New York Times, April 11, 2010.

Are Lower Wages American Workers' Future?

The only way many of today's jobless are likely to retain their jobs or get new ones is by settling for much lower wages and benefits. The official unemployment numbers hide the extent to which American workers are already on this downward path. But if you look at income data you'll see the drop.

Among those with jobs, more and more have accepted lower pay and benefits as a condition for keeping them. Or they have lost higher-paying jobs and are now in new ones that pay less. Or new hires are paid far lower wages than the old. (In January, Ford Motor Co. announced that it would add 1,200 jobs at its Chicago assembly plant but didn't trumpet that the new workers will be paid half of what current workers were paid when they began.) Or they have become consultants or temporary workers whose pay is unsteady and benefits nonexistent.
***
The likelihood, therefore, is that as the economy struggles to recover and today's jobless begin to find work, the median wage will continue to fall—as it did between 2001 and 2007, during the last so-called recovery.

More Americans will be working, but for pay they consider inadequate. The approaching recovery will be tepid because so many people will lack the money needed to buy all the goods and services the economy can produce.

From "The Jobs Picture Still Looks Bleak" by Robert Reich in the Wall Street Journal Opinion, April 12, 2010. Reich is a professor of public policy at the University of California at Berkeley and former secretary of labor under President Clinton.

SEC Proposal On Asset Backed Securities

SEC Proposes Rules to Increase Investor Protections in Asset-Backed Securities

FOR IMMEDIATE RELEASE
2010-54

[Firefox browsers will need to install Microsoft's Window Media Player Plugin]

Video: Open Meeting

Chairman Schapiro Discusses ABS:
Windows Media Player
QuickTime

Washington, D.C., April 7, 2010 — The Securities and Exchange Commission today proposed rules that would revise the disclosure, reporting and offering process for asset-backed securities (ABS) to better protect investors in the securitization market.

---

Additional Materials

• Proposal on Asset-Backed Securities
• Submit comments on this proposal

---

The proposed rules are intended to provide investors with more detailed and current information about ABS and more time to make their investment decisions. The proposed rules also seek to better align the interests of issuers and investors by creating a retention or "skin in the game" requirement for certain public offerings of ABS.

"The rules we are proposing stem from lessons learned during the financial crisis," said SEC Chairman Mary L. Schapiro. "These rules if adopted would revise the regulatory regime for asset-backed securities in order to better protect investors."

Asset-backed securities are created by buying and bundling loans — such as residential mortgage loans, commercial loans or student loans — and creating securities backed by those assets, which are then sold to investors. Often, a bundle of loans is divided into separate securities with different levels of risk and returns. Payments on the loans are distributed to the holders of the lower-risk, lower-interest securities first, and then to the holders of the higher-risk securities.

Most public offerings of ABS are conducted through expedited SEC procedures known as "shelf offerings." ABS offerings also are sold as private placements which are exempt from SEC registration. ABS private placements are typically sold to large institutional investors known as qualified purchasers (QIBs).
Public comments on the proposed rules should be received by the Commission within 90 days after its publication in the Federal Register.

# # #

FACT SHEET

Overview:

During the financial crisis, ABS holders suffered significant losses and the securitization market has been relatively dormant ever since. The crisis revealed that many investors were not fully aware of the risk in the underlying mortgages within the pools of securitized assets and over-relied on credit ratings assigned by rating agencies, which, in many cases, turned out to be wrong.

The proposed rules seek to address the problems highlighted by the crisis and to head off the next one, by giving investors the tools they need to accurately assess risk and by better aligning the interests of the issuer with those of the investor.

The Proposed Rules:

Specifically, the Commission's proposals would:

Require the Filing of Tagged Computer-Readable, Standardized Loan-Level Information

Under the current ABS rules, information about the loans in an ABS pool is required only at the pool level. The SEC will consider whether to propose new disclosure rules that would require ABS issuers to provide specific data for each loan in the asset pool both at the time of securitization and on an ongoing basis.

The loan-level data would cover items such as the terms and underwriting of the loan, credit information about the borrower, and/or characteristics of the property securing the loan. To make the required information comparable among issuers of the same asset class and more useable to investors, the rules require that the data be provided according to proposed standards and in a format tagged in eXtensible Markup Language (XML) so that it may be processed by computer. This would enable investors to synthesize large amounts of data about the underlying assets.

Examples of the types of information that would be provided for each loan in the pool include:

• A number identifying each loan so that the loan and its performance can be tracked throughout the life of the security.
• Disclosure of whether or not the loan was made without following the stated loan underwriting standards.
• Disclosure of the extent to which the obligor's income was verified (e.g. did the lender look at W-2 forms and tax returns?).
• Detailed information about the steps being taken by the servicer to limit losses on loans that are not being paid in full.

The proposal requiring loan-level information would apply to ABS issuers that offer securities backed by residential mortgages, commercial mortgages, automobile loans and leases, equipment loans and leases, student loans, floorplan financings, corporate debt, and ABS backed by other ABS.

ABS that are backed by credit card receivables may have millions of accounts in the pool, so those offerings would be exempt from loan-level information requirements. However, proposed new rules would require issuers to disclose more granular information regarding the underlying credit card accounts in tagged, computer-readable and standardized groupings. Under the proposed rules, issuers of ABS backed by credit cards would present statistical data about accounts with similar characteristics grouped by credit score range, age of account, payment status, and geographic location.

Require the Filing of a Computer Program That Gives Effect to the Waterfall

The SEC will consider a proposal requiring, along with the filing of a prospectus for an ABS transaction, the filing of a computer program that demonstrates the effect of the "waterfall." As noted above, the waterfall dictates how borrowers' loan payments are distributed to investors in the ABS, how losses or lack of payment on those loans is divided among the investors and when administrative expenses such as servicing those loans are paid to service providers. Currently, a narrative description of the waterfall must be disclosed to investors in the prospectus. The computer program of the waterfall would allow the user to input the loan level data that would also be required to be provided, as described above, giving investors and the markets better tools to analyze an ABS offering.

Provide Investors with More Time to Consider Transaction-Specific Information

The SEC will consider whether to impose time limits before a sponsor of the ABS can conduct the first sale in a shelf offering. Under current rules, issuers may sell ABS almost immediately, without providing investors a minimum amount of time to review the disclosure in the offering materials.

The SEC will consider whether to propose requiring that issuers, for each off-the-shelf takedown or offering, file a preliminary prospectus at least five business days before the first sale in the offering. This would give investors time to consider transaction-specific information, including the loan level data described above, before an investment decision needs to be made.

Repeal the Investment Grade Ratings Criterion for ABS Shelf-Eligibility

Under existing rules, an ABS offering is not eligible for an expedited offering unless the securities are rated investment-grade by a credit rating agency. The SEC will consider whether to propose new ABS "shelf" eligibility criteria to enhance the type of securities that are being offered and the accountability of participants in that securitization chain.

The proposals would require, as a condition for shelf-eligibility, that:

The chief executive officer of the ABS issuer certify that the assets have characteristics that provide a reasonable basis to believe that they will produce cash flows as described in the prospectus.

The ABS sponsor hold five percent of each class of asset-backed securities and not hedge those holdings.

The ABS issuer provide a mechanism whereby the investors will be able to confirm that the assets comply with the issuer's representations and warranties, such as representations and warranties that the loans in the ABS pool were underwritten in a manner consistent with the lenders' underwriting standards.

The ABS issuer agrees to file Exchange Act reports with the Commission on an ongoing basis (rather than stop reporting with the Commission in the first year, which the Exchange Act currently permits many ABS issuers to do).

While ratings would continue to be allowed for ABS offerings, the proposed rules would eliminate the ratings requirement from the SEC's expedited shelf-eligibility test. Additionally, the added information and time provided under the proposals should allow investors to perform their own analyses and rely less on ratings.

Increase Transparency in the Private Structured Finance Market

The SEC will also consider whether to propose disclosure requirements that would increase transparency in the exempt private structured finance market where some types of asset-backed securities, such as collateralized debt obligations (CDOs), are sold. Under these proposals, where an SEC safe harbor (e.g., Rule 144A or Regulation D) is relied upon for the unregistered sale of securities, the issuer must provide investors, upon request, at the time of the offering and on an ongoing basis, the same information that would be required if the offering were registered with the SEC or if the issuer were required to report with the SEC under the Exchange Act.

The SEC also will consider a proposal to require that an ABS issuer file a public notice of the initial placement of securities to be sold under Securities Act Rule 144A. This notice would require information about those ABS offerings and would be publicly filed with the SEC in its EDGAR database. Form D, the notice of an offering made in reliance on Regulation D, also would be revised to collect information on structured finance products.

Make Other Revisions to the Regulation of ABS

The SEC also will consider whether to propose other revisions regarding ABS. Among other things, the SEC will consider whether to propose to:

• Standardize certain static pool disclosure.
• Amend the Regulation AB definition of an "asset-backed security" to better ensure that investors have sufficient information about the securities.
• Require additional information regarding originators and sponsors, such as information for certain identified originators and the sponsor relating to the amount of the originator's or sponsor's publicly securitized assets that, in the last three years, has been the subject of a demand to repurchase or replace.
• Lower the threshold change in the material pool characteristics that triggers the filing of a Form 8-K (pursuant to Item 6.05) from five percent to one percent.
• Specify, in addition to the loan-level proposed requirements, the disclosure that must be provided on an aggregate basis relating to the type and amount of assets that do not meet the underwriting criteria that is described in the prospectus.

http://www.sec.gov/news/press/2010/2010-54.htm

Bond Markets Predicting An Almost Doubling Of The 5 Year Treasury Rate

The US Treasury Bond Market, as of 2:00 PM in NY, is predicting an almost doubling of the interest rate on future 5-year US Treasury Bonds.

Bloomberg reported yields show the 10-year Treasury yield at 4.00 percent and the 5-year Treasury yield at 2.75 percent.

The market is expecting 5-year US Treasury Bond yields to jump to 5.27 percent. Rates are expected to rise by more than 2.5 percent, or almost double the current rate.

The market expectation of the 5-year bond interest rate after the maturity of the current 5-year US Treasury bond can be derived from the yields on the current 5 and 10-year bonds.

The 10-year yield is the average of the yield of the current 5-year Treasury bond and the expected yield of a 5-year Treasury bond issued at the maturity of the current five year bond for the remaining 5 years until the end of the term of the current 10-year Treasury bond.

Similar types of calculations can also be computed for inflation from the Treasury Inflation bonds (TIPS) and the regular US Treasury Bonds.

The inflation rate for the next five years is expected to average around 2.2 percent and then rise to an average 2.3 percent for the following five years.

The modest change in expected inflation shows that the increase in future interest rates will mostly come from an increase in the real rate of interest. The real rate of interest is expected to rise from the current .52 percent to around 2.37 percent, as the Federal Reserve stops artificially keeping short-term interest rates low, and as the economy recovers.

Markets Bet Against The Discovery of A Higgs Boson Particle

Observation of the Higgs Boson Particle
Higgs Boson Particle to be observed on/before 31 Dec 2013.


Intrade markets bet against a Higgs Boson particle found before December 31, 2013. The price has dropped from 50 to 29 in the last few months even as the Large Hadron Collider began to smash sub-atomic particles together and record the data of their collisions for analysis.

The Higgs Boson is considered the most likely current candidate for our understanding of mass. If the LHC does not find a Higgs Boson then alternative theories of mass will become much more likely.

if the Higgs Boson does not exist, then the very successful Standard Model of particle physics will have to be reworked.

To date all tests confirm the Standard Model, which unites and explains the three of the four main forces of nature, the weak force, the strong force and the electromagnetic force. It does not explain or unite with the other three forces, the fourth force, gravity. It also does not explain dark matter or dark energy.