The strategic advisory firm, the Aite Group recently sent a letter to clients warning of the serious ramifications of the Securities and Exchange Commission (SEC) versus Goldman Sachs saga, as it relates to proposed financial regulations. The note is particularly apt as the Senate is now debating the financial regulatory reform package. Sen. Mitch McConnell (R-KY) said Americans want a number of things “fixed” in the bill, while Sen. Chris Dodd (D-CT) urged Republicans to unite for a debate of the bill, according to the Associated Press. “If you want to vote against this bill, do so,” Dodd said. “You can’t get to that conclusion unless we have the product in front of us.” Dodd. According to the Aite letter, press reports that frame the suit in “black” and “white” hats are stifling objective views on the way the securitization and credit default swap markets operate. The document, provided to HousingWire, warns that if what Goldman is accused of — that is, structuring a deal at the expense of collateralized debt obligation (CDO) investors — is not properly assessed, then “poorly crafted legislation distorting the fundamental roles of the market participants may potentially adversely affect the securitization and derivatives market,” writes senior analyst John Jay in the Impact Note. According to the research, buyers in synthetic CDOs are normally aware that their products will perform according to collateral performance. The executive director of the Goldman structured products group trading, Fabrice Tourre, denies the allegation that he knowingly made misleading statements about the CDO transaction, ABACUS 2007-AC1. This falls in line with the Aite note that states that “any diminishment of assets will mean a smaller base from which the collateral manager can generate his compensation.” At the time deals such as ABACUS were being structured, leverage requirements were such that $5m in capital could support $1.5bn in CDO issuance, as “leverage magnifies returns when the bet is correct, but magnifies losses when the bet is wrong.” Skin in the game requirements will likely prevent this sort of leveraging going forward. Further, the argument is made that if refinancing has not dried up, ABACUS may have been able to refinance collateral out of the deal leaving no credit losses. “The key is drafting reform that doesn’t wrongly attack phantom targets or wrongly punish market participants,” the text states. “The financial system should not be structured to insulate against all failure all the time; it is the risk of failure that creates markets.” Write to Jacob Gaffney. Disclosure: The author holds no relevant investments. John Jay holds ownership of Goldman Sachs preferred shares.
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