Securities firms and banks sold "too many lottery tickets" tied to U.S. mortgages and failed to look closely enough at their growing risks, the head of the Securities and Exchange Commission's market regulation division said Wednesday.
Financial companies had "a significant risk-management failure" on so-called super-senior classes of collateralized debt obligations made up of asset-backed bonds, according to the text of remarks Erik R. Sirri made at a New York conference.
Merrill Lynch & Co., Citigroup Inc. and other banks that underwrote those collateralized debt obligations, or CDOs, have announced mortgage-related losses for the third and fourth quarters of at least $47.2 billion -- a tally that also includes other holdings, according to data from JPMorgan Chase & Co. Losses on CDOs could reach $77 billion for the banks and about $260 billion marketwide, JPMorgan said.
The CDO classes were "a perfect structure to lull even sophisticated traders and risk managers into a state approaching complacency," Sirri said.
CDOs repackage pools of assets including sub-prime mortgage bonds into new securities with varying degrees of risk. Super-senior classes of mortgage-bond CDOs -- the least likely to be hurt by defaults on underlying securities -- probably will lose 20% to 80% of their value, JPMorgan said.