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Wall Street Dupes Retirees with Derivatives

When Wall Street cannot find any more sucker institutions, they start packaging up garbage and selling it to individuals.  The truth is that Wall Street in the United States has traditionally stayed away from the retail investor because there are many laws attempting to protect naive individual investors from the swarthy fox that is Wall Street.  Now that Goldman was fined for selling to the “sophisticated institutional buyers”, it will be interesting to see if the shackles have come off and Wall Street sells to anyone with a few dollars in hand.

“With U.S. interest rates near zero percent, investors are snapping up bonds such as reverse-convertible notes with knock-in put options or Leveraged CMS Curve and S&P 500 Index Linked Callable Notes, some with face values of as little as $10.

“People develop a product which makes a modicum of sense, then they extend it to the point of ludicrousness until it blows up,” said Satyajit Das, a former Citigroup Inc. derivatives banker.”

Remember that Satyajit Das wrote the highly entertaining book “Traders, Guns, & Money” which chronicled the exploits of investment banks selling derivatives to naive institutions.

And how did this benefit come to retail investors?

“Wall Street began selling the notes to individuals in the 1990s. At the time, government officials questioned whether the securities should be subject to the same rules as the derivatives they contain, which would have barred sales to the public, according to Philip McBride Johnson, a former Commodity Futures Trading Commission chairman. The passage of the Commodity Futures Modernization Act in 2000 settled the issue in the banks’ favor.

The law, which excluded most trades between institutions from oversight, allowed banks to sell OTC derivatives to individuals as long as they were bundled with bonds into so- called hybrid securities, said Johnson, now a lawyer at Skadden, Arps, Slate, Meagher & Flom LLP in Washington.”

One easy way to discern if your broker is selling you garbage: If the yield seems too good to be true then it most likely is.    When long duration investment grade corporate bonds are currently yielding 4.5%, any promise of interest greater than 6%  will be riddled with a) credit risk, b) leverage or c)optionality.  There is no free lunch, so your principal will be at risk.

Read the full Bloomberg article here.

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