Letter

Financial innovations

A wave of monitoring has begun to sweep Wall Street recently. The US Securities and Exchange Commission has charged Goldman Sachs for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the US housing market was beginning to falter.

This financial product refers to the synthetic collateralized debt obligation (CDO) that was related to the performance of subprime residential mortgage-backed securities (RMBS).

Fairly speaking, though very complex, the innovative product is not a devil itself. But if incorrectly used, the good product can become a devil. The Goldman Sachs' fraud charge is a case in point.

According to the SEC, Goldman Sachs failed to disclose to investors all the vital information about the CDO, including the important stakeholders, returns and risks in particular. And it told some investors on purpose that the securities were selected by an independent, objective third party. At the same time, the investment bank misled the independent, objective third party into believing its interests could be guaranteed as well.

The financial titan seems to have engaged in a dishonest game in which only itself could be the biggest winner.

The dishonest behavior failed to provide the financial innovations on a fair basis and in a correct method, thus increasing the information asymmetry in the market and ruining the fair-trade rules.

What is worse, the improper behavior seriously destroyed the image of innovative products among the public as well as regulators, and prevented the financial market from developing healthily and steadily based on constructive innovations.

All the spots can only be washed out by the authority's strict punishments, and all the lost confidence can only be restored by the industry's self-regulation and constructive financial reforms. In my opinion, financial institutions should be required to make public the source of their brokerage business and proprietary business, so that the moral hazard can be avoided to the utmost extent.

Lu wei, via e-mail

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(China Daily 04/26/2010 page9)