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Wall Street Is Pushing Risk Again

June 14, 2013 Blog

Despite bringing the economy to the brink of collapse in 2008 with excessively risky investments, Wall Street appears to have learned nothing from this near-death experience.

Rather than recommending investments of a safer nature, Wall Street is once again hawking the riskiest of investments. According to the Wall Street Journal’s Katy Burne, top investment banks are back to assembling so-called “Synthetic Collateralized Debt Obligations” (CDOs).

Remember, derivatives like CDOs were famously referred to as “financial weapons of mass destruction” by Warren Buffett. They’re not really investments but just bets on bets which almost tanked the global economy when they went bad.

And investment bankers, hungry for the fat fees such deals kick off, are out in the financial marketplace pushing CDOs again, according to the Journal.

“Investors are once again clamoring for a risky investment blamed for helping unleash the financial crisis: the synthetic CDO,” Burne wrote. “In a sign of how hard Wall Street is trying to satisfy voracious demands for higher returns amid rock bottom interest rates, J.P. Morgan Chase & Co. and Morgan Stanley bankers in London are moving to assemble synthetic collateralized debt obligations.”

“While spreading risk in some ways, synthetic CDOs also can multiply the financial damage if companies fall behind on their debt payments,” Burne reported.

In addition, brokers are encouraging retail investors to use margin to juice their stock buying. It was recently reported that the amount owed on loans secured by margin investments rose to $384 billion at the end of April 2013, the first time the total has passed the 2007 peak of $381 billion.

Investing through margin boosts returns on the upside. But, when the market corrects or tanks, investors using margin loans are forced to sell out positions without notice. In turn, their gains – and often their life savings – can be decimated.

That level of borrowing is a warning sign to investors about an overheated stock market, wrote Floyd Norris of the New York Times.

“The latest total of borrowing amounts to about 2.4% of GDP, a level that in the past was a danger signal,” Norris wrote. Margin levels reached such dangerous levels at the end of 1999, right before the technology-stock bubble burst. Margin debt fell after that but then rose again during the housing boom. And we all know how that ended.

All this could be an indication that the stock market rally, which carried the S&P 500 to record levels in May, is kaput, Norris noted.

Despite the disasters of 2000 and 2008 for investors, Wall Street just doesn’t seem to get it. The lure of fees and commissions on exotic products like CDOs and margin lending is just too tasty for investment bankers and brokers to ignore. Uncle Sam might bail out the banks in the next crash, but he won’t bail out mom and pop, that’s for certain.

Zamansky LLC are securities fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.