Or take the case of Goldman Sachs (and other Wall Street banks) who continue to make money by underwriting other firms TARP loans being paid back. In a convoluted (and unfair) manner, Goldman Sachs takes TARP money, pays it back at a lower premium, then underwrites others' paybacks and earns hefty fees for so doing!
Then because there seems to be no distinct definition of proprietary trading, Goldman Sachs can test or extend the limits of that definition to pursue further profit which it has become used to enjoying. If market making and proprietary trading are on the same continuum, then Goldman Sachs has a lot of leeway with which to work as shown by the following article by Christine Harper in Bloomberg:
Goldman Special Situation Profit Seen at Risk With VolckerRead the full article here
by Christine Harper - Bloomberg
March 28 (Bloomberg) -- For Goldman Sachs Group Inc.’s Special Situations Group, disasters can be a source of some of the biggest profits. Now the secretive investing operation faces its own potential calamity.
Goldman Sachs already has shut two units that made bets with the company’s money because such proprietary trading by banks will be prohibited under the Volcker rule approved by Congress last year. Still, the Special Situations Group, known as SSG, continues to make investments and named a new global head last month. Executives have argued that SSG shouldn’t be affected because it’s more of a lending than a trading business.
Created during the late 1990s, SSG invests the bank’s money in the debt and equity of troubled companies and makes loans to high-risk borrowers. The effort to defend it illustrates how important the business is to Goldman Sachs and may be a test of how flexible regulators will be in defining proprietary trading.
“It is proprietary trading, but the business can also be modified if you had to,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. The question, he said, is “Where will the regulators draw the line?”
While SSG’s financial results aren’t published, the unit has been a major profit contributor at New York-based Goldman Sachs -- the biggest in some periods -- according to former SSG executives who asked not to be identified because they don’t want to speak publicly about their former employer.
Twice the Profit
Investing and lending, the newly created Goldman Sachs division that includes SSG, proprietary-trading businesses and investments in hedge funds and private equity, generated 32 percent of the firm’s 2010 pretax profit, almost twice the profit from investment banking and money management combined. Only sales and trading contributed more. Until last quarter, SSG’s results were included in Goldman Sachs’s largest segment by revenue: fixed income, currencies and commodities, or FICC.
Richard M. Ruzika, 51, a former Goldman Sachs commodities- trading chief and one-time New York Jets recruit, is retiring from the firm at the end of April after running SSG since 2007, said a Feb. 17 memo obtained by Bloomberg News. He will be replaced by Jason M. Brown, a Briton who has led SSG in Asia since 2007, according to a separate memo. Brown, who joined Goldman Sachs from Bear Stearns Cos. in 1999 and became a partner in 2006, will remain in Hong Kong.
Japanese Golf Courses
The unit bought distressed assets in the aftermath of Asia’s financial crisis and profited in the Enron Corp. bankruptcy, one former employee said. A gain on an investment in Accordia Golf Co., Japan’s largest golf-course operator, contributed about $500 million to fixed-income’s $3.1 billion of revenue in the fourth quarter of 2006. The gain wasn’t disclosed by Goldman Sachs until a year later.
Without those profits, it would be difficult to generate returns previously achieved, analysts said. Goldman Sachs’s annualized return on average common shareholders’ equity was 13.1 percent in the fourth quarter of 2010, down from 41.5 percent in the same period in 2006, company reports show.
Goldman Sachs has dropped 6.1 percent this year to $157.97 on the New York Stock Exchange, compared with a 2.5 percent gain for the 81-member Standard & Poor’s 500 Financials Index.
When Chairman and Chief Executive Officer Lloyd C. Blankfein addressed investors at a conference on Nov. 11, 2008, less than two months after rival Lehman Brothers Holdings Inc.’s bankruptcy, he tried to reassure them about Goldman Sachs’s ability to make money.
“We believe we have as strong a track record as anyone at being a nimble investor in special or distressed situations,” Blankfein, 56, said. “We can decide the extent to which the firm itself will invest.”
The Volcker rule, championed by former Federal Reserve Chairman Paul Volcker, 83, and included in the Dodd-Frank Act, could change that. The provision aims to constrain banks that receive government backing, such as deposit insurance and access to Fed funds, from betting on investments that could produce significant losses. It would also limit the amount of money firms can invest in private equity and hedge funds.
The Financial Stability Oversight Council, made up of U.S. regulators, released a study and recommendations Jan. 18 on how to implement the Volcker rule. The Fed and other banking regulators must put it into effect by October.
There are unanswered questions that could leave an opening for SSG, said analysts and legal experts, including Roberta Karmel, a former member of the Securities and Exchange Commission who now teaches at Brooklyn Law School in New York. Can Goldman Sachs claim that purchasing debt makes the division a lender rather than a trader? If the unit holds its investments for months or years, do they cease to qualify as proprietary trading because the firm isn’t seeking to “profit from near- term price movements,” as the FSOC guidelines say?
“These laws are too complicated, and they can find loopholes,” said Karmel. “I don’t know how strictly the regulators will be able to define proprietary trading.”
David A. Viniar, Goldman Sachs’s chief financial officer, said on an Oct. 19 call with analysts that the Volcker rule might not affect SSG because “the predominant part of that business is actually a lending business, which we think is not only OK under the rules but is actually something that’s encouraged because it obviously helps the economy grow.”
Goldman Sachs executives don’t believe the company will be barred from using its money for so-called principal investments as long as they aren’t made through hedge funds or private- equity funds, Guy Moszkowski, an analyst at Bank of America Corp. in New York, wrote in a March 21 note to investors.
“One of the key drivers of Asia earning has historically been the ability to deploy the firm’s own capital in principal investments,” Moszkowski wrote after meeting in Hong Kong with four Goldman Sachs executives, including Yusuf Alireza, head of securities for Asia. “GS continues to believe, based on its interpretation of Volcker, that non-fund-related direct investing will not be precluded.”
Many of those investments are likely to be made through SSG or another unit called PIA, for Principal Investment Area, Moszkowski said in a phone interview after the report.
“They have been in the past, and they will be in the future,” said Moszkowski, who rates Goldman Sachs stock “neutral.” “Historically these types of balance-sheet investments have cropped up in many places around the firm, and it’s never entirely obvious that that’s a PIA investment or that’s an SSG investment.”
In his note, Moszkowski said it isn’t clear how Goldman Sachs will defend SSG’s practice of making loans to troubled companies and then receiving equity when the debt is converted to stock in a bankruptcy.
“To maximize many of these positions, SSG has followed a ‘loan-to-control’ strategy, whereby distressed-debt positions wind up as a controlling equity stake,” the analyst wrote. “Our interpretation of this has been that flat-out equity investments, or holding periods after a conversion to equity, will be very limited.”
If Goldman Sachs succeeds in convincing U.S. regulators that SSG doesn’t run afoul of the Volcker rule, new regulations from the Basel Committee on Banking Supervision could increase the amount of capital the firm has to set aside against principal investments, Moszkowski and other analysts said.