Just over a year ago, the investment world was rocked by two scandals involving highly speculative trading in unregulated Government National Mortgage Association securities (Ginnie Maes). The revelation that the University of Houston lost $17 million and a group of small banks and credit unions lost another $8 million raised at cry for federal regulation.
While the Securities and Exchange Commission and the Department of Housing and Urban Development, of which GNMA is a part, still are studying the question, the Public securities industry announced last month it had formed a new affiliate to administer a self-policing program. A few days earlier, the National Credit Union Administration, which regulates federal credit unions, had called a halt in Ginnie Mae speculation until and unless trading becomes regulated.
The Mortgate-backed Securities Dealers Association, whose 80 members account for 90 percent of the trading in Ginnie Maes, has been working on a plan for self-policing for a year. It said that it is joining with the Public Securities Association, a trade association of 260 dealers, to form the new affiliate, PSA Government Inc., which is intended to set up the policing mechanism.
Ginnie Mae pass-through securities are based on pools of FHA and VA mortgages backed by the U.S. government. As such, they are virtually risk free.
Whereas buying them is like buying a carload of wheat at a given price, the variations in Ginnie Mae trading are like commodities futures; that is, they are like betting on what the price of wheat not yet harvested will be in six months.
These variations in buying and selling Ginnie Maes include reverse repurchase agreements, forward placement contracts, standby commitment and cash forward agreements. Great gains and great losses can be experienced in these types of trading.
A reverse repo amounts to using the Ginnie Mae as collateral for a loan to buy another Ginnie Mae and so forth. If the price goes down and the purchaser has to sell, the pyramid collapses.A forward is a commitment to buy a security in the future.
A pair-off involves simultaneously buying a cash forward - one that requires mandatory delivery of the Ginnie Mae - and selling a standby commitment, where delivery is at the seller's option. To make money on the deal, the market price of the Ginnie Mae must rise past the strike price of the standby, at which time the customer then may sell the forward and decide not to deliver the standby.
The biggest scandal involved the University of Houstons endowment fund. Its manager of short-term investments, Samuel A. Harwell, used Ginnie Maes to pyramid his transactions into a multi-million-dollar operation - on paper. When interest rates went up the value of the securities went down, the university was $17 million short.
Harwell and his stepbrother, Parrick D. Sullivan, who transfered funds from te university to brokers, both pleaded guilty to federal fraud charges and were sentenced to four years each in prison.
The brokers, Aubrey Covington and Roger Knox, were indicted last month on fraud charges. Earlier that month, the SEC accused all of them plus the firm of fraud. The firm, Covington Knox Inc., is in receivership.
The other scheme was operated by Winters & Co. of Ft. Lauderdale, Fla. High-Pressure sales tactics were used to convince naive or greedy investment managers to purchase forward placement contracts with values in excess of their assets. When the investors were unable to pay, Winters, which owed about $3 million to Wall Street Ginnie Mae dealers, collapsed.
Last August the SEC revoked Winters' broker-dealer license.
The National Credit Union Administration has forwarded at least two of the 87 cases of credit unions speculating in Ginnie Maes to the SEC because of possible fraud. Actual losses have not been determined because many of the transations involving future delivery have not been completed and because many credit union managers who got burned hid these losses in their financial statements.
Asked for comment on the industry proposal for self-regulation, NCUA Administrator Lawrence Connell said, "If their proposal is adequate, we would recognize (it) as an important factor in developing our final regulation." NCUA is due to decide by December whether to ban permanently credit unions' speculation in Ginnie Maes.
SEC Commissioner Roberta S. Karmel also adopted a wait-and-see attitude. "If a self-regulatory organization for Ginnine Mae dealers is created coluntarily, registration and regulation of such dealers by the SEC is less likely," she told the industry.
While endorsing the principle of self-regulation, GNMA President John H. Dalton told the two dealer organizations last week that he, too, wanted time to study their plan.
For the plan to be acceptable to GNMA, he said, it would have to incorporate six basic elements. Among these are suitability rules that oblige the dealer to inform the customer of the risk and not let him get overextended, institution of stricter margin requirements for customers and net capital requirements for dealers, and as near-universal coverage as possible.
"It would be ultimately self-defeat-only those firms that least need to be regulated," he added. Ginnie Maes in some cases are sold by so-called "boiler room" salesman with little or not state supervision.
While endorsing the principle of self-regulation, GNMA president John H. Dalton told the two dealer organizations last month that he, too, wanted time to study their plan.
For the plan to be acceptable to GNMA, he said, it would have to incorporate six basic elements. Among these are suitability rules that obligue the dealer to inform the customer of the risk and not let him overextended, institution of stricter margin requirements for customers and net capital requirements for dealers, and as near-universal coverage as possible.
"It would be ultimately self-defeating to create a plan that regulates . . . only those firms that least need to be regulated," he added.Ginnie Maes in some cases are sold by so-called "boiler room" salesmen with little or no state supervision.