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(Mark Lennihan/Mark Lennihan/AP)
(Mark Lennihan/Mark Lennihan/AP)

SEC widens probe of Wall Street Add to ...

As suspicion grows about Wall Street's behaviour in the mortgage meltdown, so do the number of investigations.



No longer is Goldman Sachs Group Inc. the sole major target. The Wall Street Journal reported that the U.S. Justice Department has opened a criminal probe of Morgan Stanley's role in creating and then betting against complex pools of subprime mortgage bonds as the housing market cratered. And a separate report indicated that the U.S. Securities and Exchange Commission has subpoenaed documents from Deutsche Bank AG and Citigroup Inc. as part of its investigation of similar mortgage-related pools, known as collateralized debt obligations.

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Like the SEC's case against Goldman, the probes raise new questions about the activities of the country's biggest investment banks in the years leading up to the financial crisis.



U.S. authorities are trying to determine if any laws were broken when the market for these complex mortgage securities collapsed in 2007 and 2008, leaving the global financial system near ruin.



For many Americans, the verdict is already in: Once revered as the engine of the free enterprise system, Wall Street is now seen as a casino, or worse, a game rigged for the benefit of a few.



The fundamental problem is that too much of what Goldman and Morgan Stanley do enriches its traders, while providing limited value to the broader financial system, argued Lawrence Mitchell, a business law professor at George Washington University and author of The Speculation Economy: How Finance Triumphed Over Industry. They're investing and trading as if they were day traders, but with the benefit of an implicit government guarantee, he said.



In the end, it may not matter whether any laws were broken, Prof. Mitchell said.

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"The real scandal is that we permitted much of this conduct to go on, legally, without enough regulation," he said. "We've allowed these banks to gamble with the world economy."



Recent polls show that a solid majority Americans no longer trust Wall Street and endorse the Obama administration's push for much tougher regulation. In a recent ABC News poll, 60 per cent of respondents said banks and other financial institutions are responsible for either "a great deal" or a "good amount" of the country's economic woes. Nearly as many said they're "angry" at Wall Street banks.



Speaking last week as current and former Goldman executives prepared to testify to his committee, Senator Carl Levin of Michigan seemed to sum up the mood of many Americans when he said Wall Street has lost its way.



"[Goldman Sachs']conduct brings into question the whole function of Wall Street, which traditionally has been seen as an engine of growth, betting on America's successes and not its failures," said Mr. Levin, chairman of the Senate permanent subcommittee on investigations, which is also probing the financial crisis.



"We need to understand … how Wall Street turned bad mortgage loans into economy-wrecking financial instruments."



Some pundits say they already know the answer. Author Michael Lewis, a former Wall Street trader, argues in his best-selling book, The Big Short: Inside the Doomsday Machine, that Morgan Stanley was a key actor in making risky bets - through credit default swaps - against the very subprime mortgage securities it created and sold to institutional investors.



When the underlying mortgages started to default, the entire banking system was left stuck with a $1-trillion pile of toxic assets. Many of these securities were designed to fail, Mr. Lewis concludes.



"One trillion dollars in losses had been created by American financiers, out of whole cloth, and embedded in the American financial system," he writes. "Each Wall Street firm held some of those losses, and could do nothing to avoid them. No Wall Street firm would be able to extricate itself, as there were no longer any buyers."



On Wednesday, the Wall Street Journal reported that the U.S. Attorney's office in Manhattan has opened a preliminary investigation into Morgan Stanley's role in so-called "Dead Presidents" deals, named after U.S. presidents James Buchanan and Andrew Jackson. The newspaper reported that Morgan Stanley arranged and sold to investors pools of bond-related investments, or CDOs, while its own traders were betting their value would fall.



Morgan Stanley insisted it's unaware of any criminal probe of its activities. Speaking in Tokyo Wednesday, chief executive officer James Gorman said, "We have no reason to believe there is any substance behind any supposed investigation."



Experts said investigators may have a tough time drawing the line between unethical and illegal behaviour because the financial products involved are so complex.



Yves Smith, a Wall Street veteran who runs New York-based financial consultant Aurora Advisors, pointed out in his Naked Capitalism blog that the Dead Presidents deals are symptomatic of the murky CDO market, where investment banks were involved in various sides and stages of deals.



"In such an opaque market, there is a lot of bad stuff that could have gone on," he said.

Follow on Twitter: @barriemckenna

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