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Senators Target Wall Street, With Goldman Sachs in Mind

Shahien Nasiripour

The Wall Street sign is seen in front of the New York Stock Exchange, October 8, 2009 file photo. (REUTERS/Chip East)

A quintet of Democratic senators introduced legislation Wednesday to
specifically prohibit investment maneuvers that have been likened to "selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars".

Senators Jeff Merkley (Ore.), Carl Levin (Mich.),
Sherrod Brown (Ohio), Ted Kaufman (Del.) and Jeanne Shaheen (N.H.) are
pushing the Obama administration's proposal to rein in banks' Wall
Street-like practices, such as trading securities for their own profit,
while they enjoy the protections afforded by U.S. taxpayers through
deposit insurance and access to cheap funds courtesy of short-term
loans from the Federal Reserve. Their legislation also attempts to
sever the ties between banks and largely unregulated hedge funds and
private equity funds -- firms that invest and bet for the benefit of
their investors.

Those two proposals try to resurrect the wall between Main Street
banking and Wall Street trading, a Depression-era reform that was torn
down during the Clinton administration. After excessive risk-taking by
Wall Street culminated in the worst economic crisis since the Great
Depression, necessitating hundreds of billions of dollars in a
taxpayer-funded bailout, top economists and Wall Street veterans have
come out in favor of at least partially restoring that divide.

But it's the last two pages of the 11-page bill that gets to the
heart of what's been referred to as the most egregious of Wall Street
practices -- packaging and selling securities, like those backing home
mortgages, to investors worldwide, and then taking contrary positions
against them in case they default. Or as Financial Crisis Inquiry
Commission Chairman Phil Angelides put it to Goldman Sachs chief
executive Lloyd Blankfein during a public hearing in January:

"Your firm sold a significant amount of subprime
mortgage-related securities. And it appears, at least according to
public documents and other reports, that you may have simultaneously
betted against the securities you sold to clients. According to the
reports, you sold about $40 billion in 2006, 2007. In December 2006, I
think, you came to the conclusion the mortgage market was heading south
and you began to reduce your own positions.

And many of the securities that you sold to institutional
investors, other folks went bad within months of issuance. Now, one
expert in structured financing said, 'The simultaneous selling of
securities to customers and shorting them because they believe they are
going to default is the most cynical use of credit information that
I've seen.'

Do you believe that was a proper legal, ethical practice? And would
the firm continue to do that practice? Or do you believe that's the
kind of practice that undermines confidence in the marketplace?"

After Blankfein explained that Goldman sells these positions to
investors who want them, and then takes contrary positions to protect
itself against that risk, Angelides distilled it to its most elemental

"It sounds to me a little bit like selling a car with
faulty brakes and then buying an insurance policy on the buyer of those

In an interview, a Senate aide said that's exactly what the proposed legislation attempts to end.


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The aide, who spoke on the condition of anonymity because he wasn't
authorized to comment publicly, said that's what the senators had in
mind when the legislation was drafted.

According to the text of the bill, firms involved in bringing an
asset-backed security to market -- like those backing home mortgages --
shall not, at any point while the security is held by investors, take
any position that would create a "material conflict of interest" or
"undermine the value, risk, or performance of the asset-backed

The bill "would address fundamental conflicts of interest associated
with the sale of packages of securities made up of loans," according to
a summary provided by the senators' offices.
"Some financial firms put together and sold securities to their clients
and then bet heavily against them. As some have noted, this is like
building a car with no brakes, and then taking out life insurance on
the purchasers. The [bill] would establish strong conflicts of interest
protections to protect clients from these unfair and deceptive

In short, firms that sell interests in these securities to investors
can't go out into the market and make bets that they'd fail. Or as
Angelides told Blankfein:

"And let me just tell you, as someone who's been in business for
half my career, the notion that I would make a transaction with you and
then the person with whom I made that transaction would then bet that
that transaction would blow up is inimical to me."

READ the bill below:

PROP Trading Act


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