(Bloomberg News) A gray-haired woman picking a flower with a young girl adorns the cover of an HSBC Holdings Plc brochure that promises investors both "the growth of the market" and "the security of FDIC Insurance."
By tying interest rates to everything from the Dow Jones Industrial Average to precious metals, the pamphlet for HSBC's Market-Linked Certificates of Deposits explains U.S. investors have the potential to earn "enhanced returns" over as long as seven years. A separate disclosure states that they also may earn zero, getting just their original principal back after the CD matures, while brokers may collect fees of 6 percent or more. Investors that need to get their money earlier must find a buyer for the CD, risking a loss.
As the Federal Reserve holds interest rates at about zero for a fourth year, Goldman Sachs Group Inc., Citigroup Inc. and the rest of Wall Street are selling record numbers of the CDs to savers seeking the chance to earn eight times what fixed-rate deposits pay, while having principal backed by the Federal Deposit Insurance Corp. Officials at the Financial Industry Regulatory Authority, or Finra, said they're looking at whether buyers understand the risks of CDs that may lock up money in derivatives bets for as long as 20 years.
'Hugely Profitable'
"They are hugely profitable for the issuers, much more profitable than typical CDs, and they are poorly understood by retail investors, who will not be able to figure out how much profit the issuers are making," said Frank Partnoy, a University of San Diego law professor and former Morgan Stanley derivatives trader. "The institutions that are selling them might as well be marketing CDs whose value depends on which team wins the Super Bowl."
Sales of the investments may total $25 billion a year, Sean Gordon, who oversees distribution of market-linked CDs in the U.S. at Barclays Plc, said in a December interview. Banks sold a record 1,271 of them last year, according to StructuredRetailProducts.com, a database used by the industry, with some offering potential annual returns of as much as 24 percent by tying rates to everything from gold to Brazil's real.
Bank revenue from the investments more than tripled to $99 per million dollars in retail deposits in October from $30 in January, according to Kehrer-LIMRA Research compiled from approximately 30 lenders, including Wells Fargo & Co. and SunTrust Banks Inc.
No License Needed
The dollar amount of so-called structured CDs sold isn't known because they aren't registered with the U.S. Securities and Exchange Commission, and the brokers that sell them aren't required to be licensed by Finra.
Four years after subprime mortgages caused the worst financial crisis since the Great Depression, the government- backed insurance pool created in 1933 is guaranteeing investments that marry derivatives with what are supposed to be the safest product offered by a bank other than savings accounts.
"When banks start doing other things with insured deposits, it veers away from the intent and purpose of the FDIC insurance," said Andrew "Skip" Hove, a former acting FDIC chairman who is now an adviser at Promontory Financial Group LLC in Washington. "The FDIC was created for depositors who wanted some security of their money, so they didn't have to worry about a bank run."
As long as a CD's principal is guaranteed at maturity and risks are disclosed to investors, it's considered a bank deposit, even if tied to a basket of stocks, commodities or other assets, said James Deveney, chief of the FDIC's deposit insurance division.
Understood By Investors