EU: Goldman Case Shows Need for Stricter Rules

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CBS
The European Commission raised the prospect Tuesday of tougher regulations in response to the trans-Atlantic investigations into Goldman Sachs, even as some national regulators stressed that their banks wouldn't be exposed to similar fraud allegations.

EU Commissioner Michel Barnier called for "an end to behavior which led to such sophisticated financial products," his spokeswoman Chantal Hughes said, referring to the complicated packages of mortgage-backed securities that played such a large role in plunging the world into an economic crisis.

Barnier's call for greater regulation came after Britain's financial regulator announced a probe against Goldman Sachs International, following on the civil fraud charges against the parent bank filed by U.S. authorities last week.

The U.S. Securities and Exchange Commission alleges that Goldman sold risky mortgage-based investments without telling buyers that the securities were crafted in part by a billionaire hedge fund manager who was betting on them to fail.

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The presence of some European banks buying and selling in the market for collateralized debt obligations, or CDOs, has led to speculation that they may also be wrapped into an SEC investigation, or that authorities in Europe would take a closer look at how they structured investments before financial markets collapsed in 2007.

Among the biggest sellers of CDOs were Merrill Lynch & Co., now part of Bank of America Corp.; Citigroup Inc.; Swiss banking giant UBS; and German bank Deutsche Bank, according to a banking industry official with knowledge of the transactions. He spoke on condition of anonymity because he wasn't authorized to publicly discuss the banks' dealings.

The German government has said it may eventually press for compensation claims if evidence shows that German banks were wronged. But it hasn't said anything about examining whether German banks were involved in similarly fraudulent activity.

On Tuesday, Switzerland's financial regulator FINMA said there was no evidence that either of the two big Swiss banks - UBS AG and Credit Suisse Group had acted incorrectly.

"We have no signs of that," spokesman Tobias Lux told The Associated Press.

Lux said Swiss regulators conducted their own "big" investigation into subprime mortgages in October 2008, but that the current probe against Goldman Sachs was "strictly a U.S. investigation" and that there was no indication it would include UBS or Credit Suisse.

He also said that Swiss regulators had no information about institutional investors in Switzerland who were victims of any CDO-linked fraud.

The Swiss daily Tages Anzeiger reported that UBS was the more heavily invested bank in the market but that it doesn't expect Goldman-style prosecution after racking up 50 billion Swiss francs in losses on CDOs. UBS believes the only threat is an industrywide fine, it reported.

The bank declined to answer questions from the AP.

Andreas Venditti at the Zuercher Kantonalbank said the losses were unimportant as investigators would be concerned about how banks structured the investments.

"Who was the selecting party? This seems to be the main point with Goldman," he said. "Do the people get the relevant information? Are there conflicts of interest that are not disclosed?"

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For investors, losses aren't enough to prove fraud or malfeasance by a selling bank, he added.

"With investments, you can gain and you can lose."

Germany and Britain are concerned because their governments have bailed out banks that lost money due to what the SEC says was Goldman's misbehavior. For Germany, there's the government-owned KfW development bank and IKB Deutsche Industriebank AG, which the SEC says lost some $150 million in investments marketed by Goldman.

German banking expert Wolfgang Gerke told the AP that other banks or pension funds might be hurt by the investments marketed by Goldman Sachs. But he said very little was known, even if the SEC's brazen assault on a pillar of the global financial community had changed the game.

"The SEC is acting without respect for big names, which could indeed be a turning of the tides," said Gerke, head of the Bavarian Finance Center. "That demonstrates that the SEC is not willing to accept market manipulations by market participants."

He dismissed talk of Deutsche Bank facing any similar action as speculation.

The investigation announced Tuesday by Britain's Financial Services Authority follows pressure from Prime Minister Gordon Brown, who expressed shock over the weekend at Goldman's "moral bankruptcy" for planning multibillion dollar bonuses for its staff despite the U.S. probe.

British interest in the case is likely to focus on the Royal Bank of Scotland, which paid $841 million to Goldman Sachs in 2007 to unwind its position in a fund acquired in the takeover of Dutch Bank ABN Amro, according to the complaint filed in the United States.

The London-headquartered Goldman Sachs International, a principal subsidiary of Goldman Sachs Group Inc., said that "the SEC's charges are completely unfounded in law and fact." It said it looks "forward to cooperating with the FSA."

Barnier's proposals aim at better standardization and other measures to improve transparency and financial safety.

Derivatives are instruments whose value depends on an underlying asset, such as mortgages or stocks. They can help hedge risks. But derivatives can also produce steep losses, or huge profits, if the value of their underlying asset sinks.

In Europe, derivatives have been seen as risky business that even contributed to Greece's debt crisis.

"We need to put an end to years of murkiness and opacity and secretive behavior in this area," Hughes, Barnier's spokeswoman, said. "This should help bring back ethics and morality to the heart of our financial system which has been missing so badly."

Any EU regulation would be well served by global coordination. Unless rules in the United States, Europe and Asia are synchronized, global traders inevitably would shift investments to the most lenient markets. Some experts think Asia, including financial hubs like Hong Kong and Singapore, could attract more business if it maintains looser regulation.

Teresa Nielsen at Bank Vontobel said regulators - in the U.S. or Europe - would need a lot of evidence to bring a case against a bank like the one being levied against Goldman.

She largely dismissed the threat of new national probes, but warned that increased regulations could become a big issue for European banks if they affect derivatives profitability.

Other analysts noted that Goldman's announcement Tuesday of a doubling in first-quarter profits to $3.3 billion could lead to a greater populist push against the big banks.