Banks Add $1.8 Billion of Mortgage Debt as Volcker Rule Approved

Wall Street dealers added $1.8 billion of speculative-grade U.S. home-loan securities to their inventories yesterday as the Netherlands sold bonds to five banks led by Bank of America Corp. and Goldman Sachs Group Inc.

Trading data that includes the $5.1 billion auction by the Dutch government shows customers sold $5.5 billion of the debt to dealers, which in turn placed $3.7 billion with customers, according to Trace, the transaction reporting system of the Financial Industry Regulatory Authority. Bank of America won $1.9 billion in the Dutch sale, with Goldman Sachs getting $1.3 billion, according to a government statement.

The auction of mortgage securities acquired in the Dutch rescue of ING Groep NV during the financial crisis came a day after banks avoided their worst fears of the Volcker rule, with regulators approving a final version of the speculative-trading ban crafted to leave intact market-making operations that can also create losses for dealers. Some firms may seek to use the business or hedging permitted under the regulation to disguise trading not meant to help clients or reduce risks, according to Commodity Futures Trading Commissioner Bart Chilton.

“Of course they are going to find loopholes,” he said in a Dec. 10 Bloomberg Television interview. “They’ve got a year and half before this thing is even implemented. They are going to be looking at these gray areas with a fine-toothed comb.”

Chilton said the rule, approved by five U.S. agencies, was “rigorous and strong” and designed to prevent another trading debacle like the $6.2 billion loss by JPMorgan Chase & Co.’s London Whale last year. Changes in the final wording broadened exemptions for banks’ market-making desks, which generate more than $40 billion a year in revenue.

Morgan Stanley

Kerrie McHugh, a spokeswoman at Charlotte, North Carolina-based Bank of America and Michael DuVally of New York-based Goldman Sachs declined to comment on the trading data.

Morgan Stanley, Credit Suisse Group AG and Deutsche Bank AG also bought bonds yesterday in the auction, according to a statement from the Dutch State Treasury Agency.

Market-making, or principal trading, is the business of using a firm’s capital to buy and sell securities to and from customers while profiting on the spread and movement in prices. Proprietary trading involves banks placing speculative bets with their own capital. The Volcker rule, based on suggestions by former Federal Reserve Chairman Paul Volcker, seeks to stop banks with federally insured deposits from making such trades that could threaten their stability.

Record Losses

Even after record losses on U.S. mortgage bonds without government backing in 2007 and 2008 that helped create the Dodd-Frank legislation behind the Volcker rule, Wall Street traders have at times taken risks in the market.

Bank of America and Goldman Sachs were among banks that in 2009 increased the amount of the securities in their trading books after the U.S. announced a public-private investment program meant to purge toxic assets from lender balance sheets, according to regulatory data.

Last year, Goldman retained almost all of the $6.2 billion of non-agency mortgage bonds sold during a February auction by the Federal Reserve Bank of New York of assets acquired during crisis rescues, Trace data at the time showed. While the information usually indicates changes in size of inventories, trading after regular business hours may not be reflected.

The 21 primary dealers required to bid at Treasury auctions held $15.1 billion of non-agency home-loan bonds as of the week ended Nov. 27, the latest Fed data show. That compares with as much as $17.2 billion in July and as little as $11.9 billion in June since the information began being released in April.

Returns in the $800 billion market for non-agency mortgage bonds this year are beating fixed-income investments from corporate junk bonds to the euro area’s highest-yielding sovereign notes as America’s housing recovery bolsters the debt. The notes gained 9.6 percent in the first 11 months of 2013, according to Amherst Securities Group LP, amid losses among bonds with the least default risks caused by concern that the Fed will curb its $85 billion in monthly bond buying.

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