Regular readers know that the key to enforcing the Volcker Rule and ending proprietary trading is to require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.
With this information, every market participant can see what the banks are doing.
Having to disclose their positions is every proprietary trader's worst nightmare. With this disclosure, other market participants can now trade against the position in a way that absolutely minimizes the upside to the position while maximizing the potential downside.
Sitting onstage in Washington’s Ronald Reagan Building in July, Lloyd C. Blankfein said Goldman Sachs Group Inc. (GS) had stopped using its own money to make bets on the bank’s behalf.
“We shut off that activity,” the chief executive officer told more than 400 people at a lunch organized by the Economic Club of Washington, D.C., slicing the air with his hand. The bank no longer had proprietary traders who “just put on risks that they wanted” and didn’t interact with clients, he said.
That may come as a surprise to people working in a secretive Goldman Sachs group called Multi-Strategy Investing, or MSI. It wagers about $1 billion of the New York-based firm’s own funds on the stocks and bonds of companies, including a mortgage servicer and a cement producer, according to interviews with more than 20 people who worked for and with the group, some as recently as last year. The unit, headed by two 1999 Princeton University classmates, has no clients, the people said.
The team’s survival shows how Goldman Sachs has worked around regulations curbing proprietary bets at banks.One of the major lessons of the financial crisis is that complex regulations and regulatory oversight are not a viable substitute for transparency and market discipline.
With ultra transparency, Goldman loses its ability to work around the complex regulations and to influence the mechanism of regulatory oversight.
Former Federal Reserve Chairman Paul A. Volcker singled out the company in 2009, saying it shouldn’t get taxpayer support if it focuses on trading. A section of the 2010 Dodd-Frank Act known as the Volcker rule, drafted to prevent banks from taking on excessive risk, limits short-term investments made with firms’ capital.
The law doesn’t bar longer-term wagers. That leaves room for other risky investments, according to Matthew Richardson, an economics professor at New York University’s Stern School of Business. Bets that last months can go awry and belong outside federally backed banks, he said.
“From a systemic-risk perspective, it’s really the longer- term holdings which are of issue,” said Richardson, who heads NYU’s Salomon Center for the Study of Financial Institutions.
Michael DuVally, a Goldman Sachs spokesman, said in an e- mail that MSI engages in long-term investing and lending. A 2011 proposal for implementing the Volcker rule uses a 60-day cutoff to classify short-term trades.
“We have made changes to the strategies this business historically has employed to bring them into compliance with our current understanding of the Volcker rule,” said DuVally, who declined to make MSI executives available for interviews. “If the final rule requires additional changes, we’ll make them.”...The beauty of ultra transparency is it doesn't care whether a position is put on for the short term or the long term. The position is reported to all market participants. These participants then use the information to assess the risk of Goldman and to manage their own exposures.
Goldman Sachs, the fifth-biggest U.S. bank by assets, doesn’t report on the holdings or performance of MSI, or of the Special Situations Group in which it’s housed. That parent group, which uses the firm’s funds to profit from distressed and middle-market companies, has been a major profit center at the bank, sometimes the biggest, former executives told Bloomberg in 2011. Its holdings that year included debt of Melville, New York-based pizza chain Sbarro Inc.With ultra transparency, Goldman would have to report its holdings.
Cajide, who left SSG in 2008, called it a “very hush- hush” division because it wagers the firm’s capital.
“You don’t talk about what you’re doing,” she said. “It’s Goldman’s money, right?”...
Even so, with banks pushing in Washington to limit the trading rule, not all proprietary bets were banned. Former Fed Chairman Volcker, who graduated from Princeton 50 years before Oneglia and Adamson, pushed to bar long-term investments when Dodd-Frank was written, according to three people with knowledge of the talks. He tried again when regulators drafted rules based on the legislation, they said.
“There were so many elements of the rule that in order to get it passed had to be softened quite a bit, and that may very well have been one,” Kimberly Krawiec, a law professor at Duke University in Durham, North Carolina, said of the focus on short-term trading. “There’s going to be more prop trading than what the general public and perhaps even some experts believe.”...Not if ultra transparency is used as the enforcement mechanism for the Volcker Rule and all exposure details have to be reported on an ongoing basis.
“The Volcker firewall in Dodd-Frank set up a clear distinction between lending banks and hedge funds,” said Jeff Merkley, an Oregon Democrat and one of two senators who inserted the trading ban into the legislation. “Any way you slice it, the work of the London Whale and similar setups are hedge funds, whether the trades endure days or months. The regulators have full authority and clear direction to prohibit these operations. They have stalled for two years, and it is way past time for them to act.”Congressman Merkley, to achieve your goals, simply ask that ultra transparency be adopted now.