Uncertainty haunts Wall Street
As the 'ghosts of bubbles past' come back to haunt Wall Street, investors have another reason to be wary of the 'overextended and overpriced' US market.
"The ghosts of bubbles past" have returned to haunt Wall Street, says Alan Abelson in Barron's. America's Securities and Exchange Commission has accused Goldman Sachs of securities fraud over how it structured and sold a collateralised debt obligation (CDO an instrument containing subprime mortgages bundled together) in 2007.
Goldman allegedly didn't tell investors in the CDO that a hedge fund, Paulson & Co, had been involved in choosing the derivatives that were included in the CDO. Paulson had taken out a short position against the CDO, and so would profit if it bombed, which it duly did.
This affair has created uncertainty in Wall Street, says The Economist. German and UK regulators are looking into the alleged mis-selling of the CDO, and insurance giant AIG which lost money insuring Goldman CDOs may now sue. Yet another jump in earnings, up by almost 100% year-on-year in the first quarter, kept the bank in the spotlight this week.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
But the potential ramifications go beyond Goldman alone. As John Mauldin says on Investorsinsight.com, "there's never just one cockroach". Given the sheer volume of CDOs across the industry, "if regulators look hard enough" they could surely find more evidence of "disreputable activity" in this area, says Nicholas Paisner on Breakingviews.
The really awkward point for the sector is that this comes just as law-makers are discussing a wide-ranging financial reform bill. The danger is that they will use this as "an excuse for punitive reforms", says Lex in the FT such as making banks hive off their derivatives operations. "A more aggressive push" towards financial regulation "is going to follow this news", says David Rosenberg of Gluskin Sheff.
So the industry's profitability looks set to be dented by regulators just at a time when financial industry profits, propped up by government guarantees, the steep yield curve and relaxed accounting standards, are contributing the lion's share of the recent increase in overall profits. Ex-financial earnings are up a mere 5% in the past 12 months.
As government stimuli fade and the inventory bounce wears off, non-financial profits are likely to look even less V-shaped. So post-Goldman, investors have another reason to be wary of a "seriously overextended and overpriced" market, says Rosenberg.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
-
Banks given additional 72 hours to investigate suspicious payments
New rules will allow banks to pause suspicious payments for longer, giving them time to investigate cases of potential fraud
By Katie Williams Published
-
What financial support can you get if you are suffering with long-term illness?
Health is wealth and more important than any material riches. But too often, long-term illness brings financial worries of its own. What financial support can you get if you are ill?
By Katie Williams Published