Goldman Hops Over the Volcker Fence


So much for the Volcker Rule. Although the ink from President Obama's signature is barely dry on the financial regulation bill that became law last week, investment banks are already hard at work searching for loopholes. One of the more aggressive new requirements, the so-called Volcker Rule, would limit proprietary trading to 3% of Tier 1 capital. But the rule may be easy to sidestep. Goldman Sachs is leading the way around the regulation, by simply reclassifying many of its prop traders as asset managers.

One major initial criticism of the Volcker rule was that it's hard to distinguish prop trading from market making. Goldman is using this blurry line to its advantage. Charlie Gasparino from Fox Business reports:

But by having the traders work in asset management, where they will take market positions while dealing with clients, Goldman believes it can meet the rule's mandates, avoid large-scale layoffs and preserve some of the same risk taking that has earned it enormous profits, people close to the firm say.

Goldman's move also underscores the weakness in the Volcker Rule, which was designed to reduce the same type of risk-taking activities that led to the 2008 financial meltdown. Simply by labeling a trade "customer related" the firm can still make large market bets, and thus engage in some of the same risk taking the rule was designed to eliminate.

Felix Salmon foresaw this move last week, noting how Goldman's earnings call strangely lacked any mention of prop trading, but lots of talk about trading for their clients and making markets. He explains CFO David Viniar's language:

But note how careful Viniar was to characterize Goldman's short-vol position as "a result of meeting franchise client and broader market needs." This, of course, is a way of signaling to the market that his trading desk's profits aren't going away any time soon: they're client-related, and they're not the result of the kind of proprietary trades which are going to be banned under the Volcker rule.

And that's exactly the route Gasparino says they're taking. He also says that other banks are likely to follow, with Bank of America first in line. So just how does this work? Imagine two scenarios:

Prop Trading

A bank senses that XYZ corp is going to collapse. So its prop traders short the stock by selling stock option contracts to investors who want to bet long on XYZ's continued success.

Asset Management

A bank senses that XYZ corp is going to collapse. So its prop traders asset managers short the stock by selling stock option contracts to investors their clients who want to bet long on XYZ's continued success.

You may have noticed that, other than the two strikethroughs which merely changed terminology, those two descriptions were identical. The firm accomplishes precisely the same end. The Volcker rule, thus, boils down to semantics. It's only prop trading if you fail to classify a trade as "client related." And there it is -- the first big loophole in the new financial regulation bill found and exploited. It barely took a week.

The score so far: Big Banks 1, Congress 0

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.
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