The Dirty Little Secret Of The Dodd-Frank Legislation

“The dirty little secret of the Dodd-Frank legislation is that by failing to curtail the worst abuses of the OTC market in structured assets and derivatives, a financial ghetto that even today remains virtually unregulated, the Congress and the FED are effectively even encouraging securities firms to act as de facto exchanges and thereby commit financial fraud,” the Institutional Risk Analyst writes in its recent news letter.

“No more QE thank you please.¤

Institutional Risk Analyst


“With the passage of the Dodd-Frank Wall Street reform legislation, many financial analysts and members of the press believe that investment banking revenues and resulting earnings are in danger, but nothing is further from the truth,” the Institutional Risk Analyst writes.

The Volcker Rule and other limitations on the principal trading and investment activities of the largest universal banks do nothing to address the true cause of the crisis, namely the creation and sale of fraudulent securities and structured assets based on residential mortgages, toxic waste which was sold over-the-counter (OTC) as private placements and without SEC registration, according to the Institutional Risk Analyst, know for its regular publication of the IRA Bank Stress Monitor.

Here’ some more from the rather harsh commentary:

It is not own account trading but the derivatives sales desks of the largest BHCs whence the trouble lies.

Even as the big banks make a public show for the media of implementing the new Dodd-Frank law with respect to limits on own account trading and spinning off private equity investments, these same firms are busily creating the next investment bubble on Wall Street – this time focused on structured assets based upon corporate debt, Treasury bonds or nothing at all – that is, pure derivatives.

Like the subprime deals where residential mortgages provided the basis, these transactions are being sold to all manner of investors, both institutional and retail.

The Perverse Structure

It is the perverse structure of the OTC markets and not the particular collateral used to define these transactions that creates systemic and institution specific risk.

One risk manager close to the action describes how the securities affiliates of some of the most prominent and well-respected U.S.

BHCs are selling five-year structured transactions to retail investors.

These deals promise enhanced yields that go well into double digits, but like the subprime debt and auction rate securities which have already caused hundreds of billions of dollars in losses to bank shareholders, the FDIC and the U.S. taxpayer, these securities are completely illiquid and often come with only minimal disclosure.

The Dirty Secret

The dirty little secret of the Dodd-Frank legislation is that by failing to curtail the worst abuses of the OTC market in structured assets and derivatives, a financial ghetto that even today remains virtually unregulated, the Congress and the FED are effectively even encouraging securities firms to act as de facto exchanges and thereby commit financial fraud.

Allowing securities firms to originate complex structured securities without requiring SEC registration is a vast loophole that Senator Christopher Dodd (D-CT) and Rep. Barney Frank (D-MA) deliberately left open for their campaign contributors on Wall Street.

But it must be noted these same firms have a captive, client relationship with the FED and other regulators as well, thus a love triangle may be the most apt metaphor.

Of course retail investors love the higher yields on complex structured assets. Who can blame them for trying to get a higher yield than available on treasuries, while the FED keeps rates at historic lows to, among other things, re-capitalize the zombie banks.

The Only Trouble

The only trouble is that the firms originating these ersatz securities, as with the case of auction rate municipal securities, have no obligation to make markets in these OTC structured assets or even show clients a low-ball bid. And because of the bilateral nature of the OTC market, only the firm which originates the security will even provide an indicative valuation because the structures and models behind them are entirely opaque.

In fact, we already know of two hedge funds that are being established specifically to buy this crap from distressed retail investors as and when rates start to rise.

The sponsors expect to make returns in high double digits by making a market for the clients of large BHCs who want to get out of these illiquid assets. But the one thing that you can be sure of is that nobody at the FED or the other bank regulatory agencies knows anything about this new bubble.

As with the early warnings brought to the FED about private loan origination and securitization activities as early as 2005, the central bank and other regulators are so entirely compromised by the political pull of the large banks that they will do nothing to get ahead of this new problem.

Consider a specific example:

Shall We Reward Incompetence?  – The Case of Sarah Dahlgren and the FED of New York.

Read the rest at IRA’s homepage here.

Related by the Econotwist:

So, You Thought BP Was An OIL Company?

Webster Tarpley: The Financial Reform Is A Failure

Transantlantic Bailout Buddys Agree To Disagree

Civil And Criminal Probes Against JP Morgan For Silver Manipulation

Two Thirds of Americans Support Stricter Financial Regulations

Living In A Derivative World

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Filed under International Econnomic Politics, National Economic Politics