Volcker Rule won’t so quickly squelch house bets
Don’t think Goldman Sachs is finished putting its own capital at risk. The Wall Street firm may be rushing to either restructure or spin off its private equity and proprietary trading units to comply with the newly enacted Volcker Rule. But the directive remains vague and leaves ample room for Goldman and its Wall Street rivals to bet with plenty of the house’s money.
Investment banks can still use their own money if it helps facilitate trades for clients. They can mint — and burn — money doing that. The rules do, however, envisage limiting this support to what constitutes satisfying proper expected near-term demand for client trades. As ever, identifying where that ends and prop trading begins is a rather blurry line.
The Volcker Rule’s definition of prop trading is also open to interpretation. At first blush, it looks pretty watertight: the rule forbids banks from buying and selling financial products for their “trading account.” That, in turn, is defined as an account designed to profit in the “near term” from “short-term” movements in prices. Clearly that knocks on the head all manner of trades that last for no more than a few days or weeks.
But it’s unclear what period of time “near term” and “short term” are supposed to cover. Were the rule in place four years ago, for example, would it have prohibited Morgan Stanley from placing a huge short on the mortgage market that lost the firm some $10 billion? That trade, though modified at times, was in place for almost a year. It’d be hard to call it “near term.”
And banks can still trade government and agency securities for their own account. These are hardly risk free and it doesn’t take a sovereign debt crisis to prove it. Some of the problems at hedge fund Long-Term Capital Management stemmed from trying to arbitrage prices between new and recently issued 30-year U.S. Treasuries. And Carlyle’s heavily leveraged listed debt fund crashed in 2008 when prices of Fannie and Freddie mortgage bonds dropped.
Longer-term investments aren’t ruled out either — so long as they’re not part of a private equity unit. Goldman’s special situations group, for example, sits in the fixed income division, investing in securities that can take a year or more to yield returns. Rumors put this group’s pre-crisis annual profit at $1 billion. Prop trading and private equity may be dead. But long live principal investing.