Goldman: 1, Volcker: 0

January 8, 2013

By Lauren Tara LaCapra

There’s an interesting article out today from Bloomberg, which accuses Goldman Sachs of skirting the yet-to-be-defined-or-implemented Volcker rule, and accuses its top executives, including CEO, Lloyd Blankfein, of being a hypocrite.

Bloomberg reporter Max Abelson has done some good work on the subject. His article is well written and well sourced—he spoke to at least 20 people and got many of them to go on the record about their former employer and describe how Goldman continues to place bets with the firm’s own money.

Abelson concludes “Goldman Sachs has worked around regulations curbing proprietary bets at banks. “ But what the article really points out is that Wall Street will keep finding new ways to move the goal posts in its favor when it comes to defining and clamping down on prop trading.

For those who aren’t well-versed in Volckerdom, all you really need to know is that it’s named after former Federal Reserve Chairman Paul Volcker and it’s intended to prevent Wall Street firms from making the kind of big bets that could ultimately put taxpayers on the hook. But critics complain the rule, as currently envisioned, has been so watered down that it allows a lot of interpretation for what constitutes prop trading, and gives banks a lot of latitude to keep doing what they have always been doing.

Banks, for instance, will still be able to act as market makers, buying and selling securities on behalf of clients, and they may still be able to make long-term investments. All of this gives rise to questions of whether it’s still OK for banks to make a strategic investment in another company and for how long? And how do you know if a hedge trade is really a hedge?

Also, the Volcker rule does not, of course, prevent lending – which appears to be the regulatory exception the Goldman group Abelson writes about is making the most of. Indeed, in a bizarre twist of logic, some Goldman sources have been arguing that lending is the same thing as buying up distressed debt and bankruptcy claims in the secondary market, and working aggressively to turn a profit.

In an interview with Reuters in May 2011, Volcker himself said he did not think that was the case.

“I don’t see how it’s comparable to a loan,” he said in comments that were not published at the time. “If you buy an asset to trade it, that’s not a loan.”

“If you want to be a bank, follow the bank rules,” he added. “If Goldman Sachs and the others want to do proprietary trading, then they shouldn’t be banks.”

Volcker’s position, shared by others, is that banks should be following the spirit of the law, rather than the letter. (He famously compared prop trading to Supreme Court Justice Potter Stewart’s assertion about pornography: “I know it when I see it.”)

So if it looks like a prop trade, walks like a prop trade and quacks like a prop trade, then it’s a prop trade, and banks shouldn’t be doing it, and regulators should be able to spot it easily.

In theory that makes sense, but in practice it’s not clear what will happen. Regulators – who often complain of being understaffed and underfunded and overwhelmed by the amount of rulemaking work they’ve had to do – have extended the deadline for a final Volcker rule by months because of all the pushback from banks and an ongoing, vigorous debate about the costs and benefits of the rule. (The Securities and Exchange Commission, for instance, received 241 detailed unique comment letters and 14,479 form letters of support for the regulation.)

In 2010, Goldman revamped its reporting lines and isolated its lending and investing activities into one division, in which its Special Situations Group is housed. It’s possible that regulators will pass a rule that explicitly bans the kind of activity that goes on in that group, which invests the bank’s own money in troubled debt, bankruptcy notes and sometimes equity, without doing anything for clients. But it’s also possible that regulators writing the rule – which include the SEC, The Federal Reserve, The Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp and the Commodity Futures Trading Commission – might make the language vague enough to allow banks some wiggle room when it comes to the way they use their balance sheets.

But the final rule isn’t out yet, and Volcker won’t be implemented until 2014. It’s a little strange to say Goldman is breaking a rule that doesn’t exist yet, although calling executives hypocrites is less of a stretch.

Goldman executives including Blankfein and outgoing CFO David Viniar have said publicly that the bank does not have any prop trading businesses any longer, because it shut down its principal strategies and global macro trading desks, which also made bets with Goldman’s capital.

“We shut off that activity,” Blankfein said at an event in July.

“It’s been shut down,” Viniar said in February 2011.

What Bloomberg’s story does is raise an important question for shareholders, regulators and taxpayers that won’t be answered for at least a few months: Has it?

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