Goldman Sachs Knows a Loophole When It Sees It!

A couple of things are happening at Goldman Sachs these days: first, some of the prop traders are leaving GS for either another trading group or to form their own hedge funds, and, second, Goldman Sachs "is disbanding its principal strategies business." Both actions are in response to the Dodd-Frank Volcker rule which seeks to curb risk by not allowing a firm to make bets with its own money.

However, those actions are rather deceptive when you consider that the Dodd-Frank law does not clearly state what proprietary trading means. According to Michael Lewis in Bloomberg, Goldman Sachs does not have any intentions of giving up on prop trading--it is just giving it another name to take advantage of a loophole in the bill:

Proprietary Trading Goes Under Cover: Michael Lewis
by Michael Lewis - Bloomberg Opinion

A few weeks ago we asked a simple question: Why are the same Wall Street banks that lobbied so hard to dilute the passages in the Dodd-Frank financial overhaul bill banning proprietary trading now jettisoning their proprietary trading groups, without so much as a whimper?

The law directs regulators to study the prop trading ban for another 15 months before deciding how to enforce it: why is Wall Street caving now?

The many answers offered by Wall Street insiders in response boil down to a simple sentence: The banks have no intention of ceasing their prop trading. They are merely disguising the activity, by giving it some other name.

A former employee of JPMorgan, for instance, wrote to say that the unit he recently worked for, called the Chief Investment Office, advertised itself largely as a hedging operation but was in fact making massive bets with JPMorgan’s capital. And it would of course continue to do so. JPMorgan didn’t respond to a request for comment.

The fullest explanation came from a former Lehman Brothers corporate bond salesman named Robert Wosnitzer, who is now at New York University, writing a dissertation on the history of proprietary trading. He’s been interviewing Wall Street bond traders, he said, and they have been surprisingly open about their intentions to exploit one obvious loophole in the new law.

The innocent eye might have trouble spotting this loophole. The Dodd-Frank bill bans proprietary trading (Page 245: “Unless otherwise provided in this section, a banking entity shall not engage in proprietary trading”) and then appears to make it clear what that means (Page 565: “The term ‘proprietary trading’ means the act of a (big Wall Street bank) investing as a principal in securities, commodities, derivatives, hedge funds, private equity firms, or such other financial products or entities as the comptroller general may determine”).

Invitation for Abuse

The big invitation for abuse, Wosnitzer says, lies in the phrase “as a principal.” It falls to the comptroller general - - or, more specifically, the Government Accountability Office, which is overseen by the comptroller general -- to determine precisely what the phrase means.

And, at the moment, the GAO pretty clearly hasn’t the first clue. (“We’re really too early in the process to speak to how we might define it,” said spokeswoman Orice Williams Brown.)

Never mind: Wall Street is busily defining the term for itself.

Make an Argument

“One trader I interviewed,” Wosnitzer says, “said that from here on out, if he wants to take a proprietary position in a credit, he will argue that he bought the position because a customer wanted to sell the position, and he was providing liquidity; and in order to keep the trade on, he would merely offer the bonds 10 basis points higher than the offered side, so that he will in effect never get lifted out of the position, while being able to say that he is offering the bonds for sale to clients, but no one wants ‘em. When the trade finally gets to where he wants it -- i.e., either realizing full profit, or slaughtered by losses -- he will then sell it on the bid side, and move on.

Of course, there is all sorts of flawed logic here, but the point is that...there are a hundred different ways to claim to be acting as an agent or for a customer.”

This ambiguity is no doubt one reason the financial reform bill passed in the first place. Even its clearest prohibitions are couched in language inviting Wall Street to evade them.

But the new game of cat and mouse raises a simple, even naive question: Why do these giant Wall Street firms want so badly to make huge bets with their shareholders’ capital?

Save Us

After all, the point of the ban on proprietary trading is as much to save the banks from themselves as to save us from them. We have just come through a period where putatively shrewd individual bond traders lost not millions but billions of dollars for their firms, by making really stupid bets.

Even before the crisis there was never any reason to think that traders at big Wall Street firms had any special ability to gamble in the financial markets. Anyone with a talent for investing is unlikely to waste it on Morgan Stanley or Bank of America; he’ll use it for himself, or for some hedge fund, which allows him to keep more of his returns.

And if this were true before the financial crisis it is even more true after it, when trading inside a big Wall Street bank will be less pleasant and more fraught with politics.

Yet Wall Street’s biggest firms apparently still badly want their traders to be allowed to roll the bones. Why?

Read the whole article here