Bloomberg recently reported on a report by Institutional Risk Analytics Managing Director Christopher Whalen. According to the former Federal Reserve Bank of New York official, structured notes are about to become the “next investment bubble.” Whalen is the one who predicted a little over three years ago that the mortgage-backed securities market was going to collapse. Now, he says that investment firms are applying the same “loophole” that allowed auction-rate securities and collateralized debt obligations to be sold over-the-counter.
Structured notes are derivatives packaged with bonds. Their value comes in part from bets on interest rates. Accredited buyers purchase them through private deals, while the public can buy them in trades. StructuredRetailProducts.com says that structured note sales to individual investors in this country has gone up 72% to $29.6 billion in the last year.
As with ARS, the firms originating these illiquid structured notes are not obligated to “show clients a low-ball bid” or create markets in these OTC structured assets. Whalen says that even as the larger financial firms are making it appear that they are abiding by the new Dodd-Frank law (which does not allow proprietary trading and limits private-equity fund investments), they are now concentrating on structured assets that are based on Treasury bonds, corporate debt, or nothing at all.
Whalen says that it is the individual investors that will lose money on structured notes when the benchmark interest rates go up. Among the the other reasons why structured notes worry Whalen:
• They come with high risk yields.
• They are not regulated.
• They frequently come with minimal disclosure.
According to Whalen, there are already two hedge funds set up for when the rates start to rise and “distressed” retail investors will want to sell.
Individual and institutional investors that believe their financial losses are a result of broker-dealer misconduct or misleading information should explore their legal options.
Related Web Resources:
Structured Notes Are Wall Street’s `Next Bubble,’ Whalen Says, Bloomberg, August 9, 2010
Chris Whalen Gives 6 Reasons Why The Next Bubble Will Be In Structured Notes, Business Insider, August 10, 2010
Institutional Risk Analytics