February 10, 2012 / 12:00 PM / 7 years ago

RPT-Goldman subprime bet highlights Volcker debate

By Carrick Mollenkamp and Lauren Tara LaCapra

NEW YORK, Feb 9 (Reuters) - Goldman Sachs Group Inc’s purchase of a $6.2 billion portfolio of subprime bonds on Wednesday illustrates the difficulty regulators may have in stopping banks from making bets with their own money.

Goldman purchased the portfolio from the Federal Reserve Bank of New York, which is selling mortgage securities acquired in 2008 through the bailout of American International Group Inc .

Goldman held the bulk of the portfolio overnight before moving to sell the bonds en masse, according to bond-trading data and people familiar with the situation. While there was strong demand from Goldman clients, by doing so the Wall Street bank took the risk of events in Europe roiling markets and the value of those assets falling in a short period of time.

Rival banks and mortgage investors said Goldman profited when it sold the bonds at a higher price than what it paid, but it is not clear how much overall profit Goldman will make from this deal.

Goldman’s decision to hold the securities was in contrast to a similar New York Fed sale in January to Credit Suisse Group AG . The Swiss bank almost immediately sold the securities to investors eager for higher-yielding bonds, removing its holding risk, according to a person familiar with the situation.

A Goldman spokesman said, “Our intention has always been to place the portfolio with our clients globally and we are in the process of doing that.”

The bonds were held in a New York Fed portfolio called Maiden Lane II. The New York Fed didn’t disclose its sales price.

Bond-trading data for Wednesday shows that $6.9 billion in mortgage bonds — underpinned by loans to borrowers with poor credit history — were sold while only $961 million was bought, according to the Financial Industry Regulatory Authority.

That data suggests a large portfolio of bonds was injected onto a buyer’s balance sheet and then held, mortgage traders said.

The Goldman trade highlighted the problems regulators will have as they roll out a new rule aimed at limiting the risks banks take on as they make so-called proprietary bets using house money. A harsh interpretation of the rule, due to go into effect in July, could ban speculative bets. Riskier bets also require more capital to cushion against potential losses.

Investment banks that oppose a stringent Volcker rule — named for former Federal Reserve Chairman Paul Volcker — argue that they provide important liquidity in a market, just as Goldman did in facilitating Wednesday’s trade.

“If the Volcker rule had been in place, would this have run up against it? That is exactly what is being debated right now. Are trades like this going to be viewed as consistent with the proposed implementation of the Volcker rule or not?” said Darrell Duffie, a finance professor at Stanford University.

“My own view is that the definition of legitimate market-making under the Volcker rule should be fairly broad and include trades like this,” Duffie said.

To be sure, Goldman was assured it would receive strong demand for the subprime bonds. This week’s auction of the mortgage bonds generated bids from Goldman, Credit Suisse, Barclays Plc, Morgan Stanley and Royal Bank of Scotland Group Plc, according to the New York Fed.

Each of the brokers, in bidding for the portfolio of bonds, lined up customer bids for the bonds. In an indication of the demand, one bank received more than 1,000 bids.

In the bailout of AIG, Goldman and 15 other banks were fully paid for $62 billion of credit-insurance agreements they had held with AIG, according to a 2009 report by the special inspector general for the Troubled Asset Relief Program.

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