Does Goldman’s Facebook investment violate the Volcker Rule?

By Felix Salmon
January 5, 2011
Bill Cohan raises an interesting point:

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Bill Cohan raises an interesting point:

Goldman’s cost of capital is close to zero — as a bank holding company, it can borrow from the Federal Reserve at negligible interest rates — so any capital gain it makes on its venture in Facebook will be sheer profit.

Isn’t this the kind of thing the Volcker Rule was supposed to prevent? Goldman is a regulated bank, with access to essentially unlimited Federal Reserve funds at very low interest rates; it should not be using those funds for speculative bets on its own behalf. But that’s what the Facebook investment looks like.

I’m not saying that the Facebook investment is illegal — for one thing, the details of the Volcker Rule have yet to be fully hashed out, which means it doesn’t yet have the full force of law. But this does look like it violates the spirit of Dodd-Frank.

As Robert Cyran says, the deal “looks like classic merchant banking”, where banks invest as principals in client companies. Under the Volcker Rule, however, I thought that only investment banks could make such bets — not regulated bank holding companies with access to Federal Reserve funds.

14 comments

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Looks unclear:

“It is also in (Sponsoring and Investing in Private Equity) that the proposed restrictions are the least coherent. Banking groups with Financial Holding Company status are allowed by the BHCA to make so-called “merchant banking investments,” which are much the same types of investments in nonfinancial companies that private equity funds regularly make, but the Senate Bill does not appear to directly address their authority to continue engaging in this activity directly. ”

Source: http://blogs.law.harvard.edu/corpgov/201 0/06/26/volcker-rule-looms-over-asset-ma nagement-and-fund-activities-of-financia l-institutions/

Posted by Chris_Gaun | Report as abusive

wait – isn’t the whole reason GS took so much heat about the Facebook deal is because the purpose is to structure the investment and resell it to investors, evading SEC rules regarding number of owners of a private company?

said differently: no – GS is not acting in a proprietary speculative position here: they’re acting as a market maker! buying shares from Facebook and re-selling them to their clients!

Posted by KidDynamite | Report as abusive

KidDynamite, I think you’re right, except that Goldman isn’t a market maker, they are a book maker. Buying shares of Facebook at this point is more of a bet than an investment.

But isn’t that what Goldman’s speciality?

Posted by OnTheTimes | Report as abusive

OTT – but they aren’t going to hold the Facebook investment – they’re going to re-sell it, right? Helping to get around the SEC rules about maximum number of investors for private companies… GS isn’t making a bet at all – they’re just taking a little spread, as marketmakers do!

Posted by KidDynamite | Report as abusive

KD, bookies don’t hold bets, either. They adjust odds so they have an even number of bets on both sides, and they get their commission on every bet. Adjusting the odds so the bookies have little or no exposure is trickier than syndicating the purchase of sub-prime mortgage bonds or absurdly speculative pre-profit internet stocks, but the bookies seem to have gotten their system down better than companies that sold credit swaps. Maybe it’s because the bookies know if they take on too much risk and lose, they won’t get bailed out.

Posted by OnTheTimes | Report as abusive

Well of course BUT… when you consider that the revolving door and higher pay means Wallstreet can and has enticed and hired former SEC and those who helped write the Volcker rules, Wallstreet probably knows the rules and how to skirt them better then the 800 new people hired and trained to enforce them.

Facebook will peter out soon. Its growth was from teens making 100 ‘s of anonymous fake accounts to bully and bash each other with and pretend they have hundreds of friends (and who doesn’t want a piece of that action? Seriously it stymies me.)

There are few unique users and the adults I know who use it are addicted to the silly games and rarely use it as a social network. Another game comes along and a better medium and they could all desert.

The next generation of social networking will have other… newer.. better… but by then the deals will be made and Goldman can smirk at having played another shell game.

I wonder how many ‘sophisticated’ buyers they can sucker into paying more then it’s worth, before it blows up? There may be a feeling the Goldman/facebook with the man of the year cover can’t go wrong.

Unless businesses have found Facebook to be a great place to share insider information undetected, there is little growth possible.

Posted by hsvkitty | Report as abusive

If Dodd-Frank might get in the way of Goldman Sachs making money, then clearly the regulations will need to be changed….and they will be.

Posted by ErnieD | Report as abusive

My understanding is that Goldman is making this investment through GSIP, or Goldman Sachs Investment Partners, which is a hedge fund that spun off from its prop desk.

Also, Goldman’s cost of capital would be close to zero if borrowings from the Federal Reserve were its only liabilities. Last I checked, there’s GS common stock outstanding.

Posted by drzaius7734 | Report as abusive

drzaius7734, concise informative post.
Felix, maybe you could have done a modicum of research before posting to figure out what part of Goldman was investing in the deal. Instead, you just posted another thoughtless anti-Goldman screed… big surprise! You are like a pig basking the sweet filth of intellectual mediocrity.

Posted by TinyOne | Report as abusive

“You are like a pig basking the sweet filth of intellectual mediocrity.”

holy schnikeys… I need to keep that one for the archives for future use!

Posted by KidDynamite | Report as abusive

Tinyone, you sound like another creepy bank apologist. There are a plethora of other places to read about the buy, but felix asks whether it violate the Volcker rule.

According to the “sources” the Goldman purchase will be made available not just through the GSIP but other wealth management/investment partners and clients.

They are trying to fly under the radar and make more risky markets that are not regulated. What else is new… and why can’t Felix ask that question?

I loved reading about the GSIP:

“Goldman Sachs Investment Partners is an opportunistic multi-disciplinary hedge fund employing an intensive fundamental approach to investing. The Fund seeks asymmetric risk-reward opportunities to achieve equity like returns. The team has cross-market capabilities, with experience capturing synergies across the capital structure in both public and private markets.”

The connotation of opportunistic bodes poorly for the masses who are, unlike Goldman, still burning from the previous bubble, but suits them.

Posted by hsvkitty | Report as abusive

TinyOne – I understand your point if GSIP is a true spin-off at complete arms length with no interlocking boards, partners etc.

However, one of the key elements in the financial crisis were the various “off-balance-sheet” entities that turned out not to be really off the balance sheet at all. If GSIP can access Federal Reserve funding and implicit federal guarantees through Goldman Sachs, then they have an advantage that very few other businesses can even conceive of.

I am all for capitalism, but I object to capitalism where a pampered few can be backed by government resources to compete with the rest of society on an uneven playing field. That is fascism.

Posted by ErnieD | Report as abusive

The deal that GS is putting together here in some ways looks like a cousin to their Abacus deal. Particularly when you consider that the valuation of this package is around 25 times valuation (stated in a separate article). Perhaps John Paulson is again in the background shorting this package? FB does not make a product. It is a social networking site that quite frankly to me looks to have limited shelf life. Teens is particular are fickle. Expect continued competition to FB’s business model. I would suggest that we are currently seeing the top of the curve for FB. GS is merely trying to take advantage (hence the hefty upfront expense) of the FB cycle. In the end there will be GS clients (suckers) stomping out the burning bag of dog do left by their front door that GS sold them disguised as a “rare opportunity”.

Posted by xyz2055 | Report as abusive

xyz2055, it is only like Abacus if it goes down in price. Expect then investors to complain that they never ever realise that 50bn or 25 times purported earnings was a rich price. Of course if it goes up in price then no complaints….. The joys of being buyside.

Posted by Danny_Black | Report as abusive