Unregulated Structured Notes Could be the Next Investment Bubble

The collapse of the mortgage-backed securities market still has many investors feeling uneasy and reeling from their losses. The same man who predicted that collapse, Christopher Whalen, managing director of Institutional Risk Analytics, has warned about another potential “investment bubble.”

According to Mr. Whalen, who is a former Federal Reserve Bank of New York official, Wall Street banks are selling obscure and unregulated structured notes, using the same “loophole” that was applied with collateralized debt obligations and auction-rate securities. These unstructured notes promise large yields, but are light when it comes to disclosures.

Bloomberg.com defines structured notes as “derivatives packaged with bonds” that “are sold to accredited buyers in private deals and to the public in trades reported to the Securities and Exchange Commission.”

In a report, Mr. Whalen refers to these structured securities as illiquid, even though dealers claim that they will buy the securities back from investors.

“The only trouble is that the firms originating these ersatz securities, as with the case of auction-rate municipal securities, have no obligation to make markets in these OTC structured assets or even show clients a low-ball bid,” according to Mr. Whalen.

Structured notes have been on the rise. StructuredRetailProducts.com reported that sales of these securities to individual investors skyrocketed 72 percent in the United States in the last year.

Mr. Whalen warns that firms creating these structured notes are “busily creating the next investment bubble on Wall Street.”


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