Volcker Rule Gives Goldman Easy Choice

The top story at the Financial Times at this hour, “‘Volcker rule’ gives Goldman stark choice,” is a accurate report of Paul Volcker’s latest remarks, but gives a wildly misleading impression of the “choice” facing Goldman:

Goldman Sachs and other banks should give up their bank status if they want to avoid the ban on proprietary trading proposed by the White House, Paul Volcker, head of President Barack Obama’s Economic Recovery Advisory Board, said.

“The implication for Goldman Sachs or any other institution is, do you want to be a bank?” Mr Volcker said in a video interviewvideo interview with the Financial Times. “If you don’t want to follow those [banking] rules, you want to go out and do a lot of proprietary stuff, fine, but don’t do it with a banking licence.”

Yves here. Oh, so Goldman has to chose between prop trading, aka being in some high return businesses, or being a bank. But why in God’s name does Goldman want or need to be a bank?

Let’s rerun the tape on the crisis. Two investment banks, Bear and Merrill, were kept from failing subsidized mergers into banks. The conventional wisdom is that allowing Lehman to fail was a really bad idea, although a significant minority school of though holds that if there was a better organized way for Lehman to have failed, maybe that would not have been so terrible. Morgan Stanley and Goldman got cheap money, TARP equity, access to lotsa special facilities to keep them from falling over. They were given banking licenses simply to make it legally (and therefore operationally) easier for the Fed to give them access to emergency cash.

So what is the lesson? If you are a big enough player in the financial markets, you will not be permitted to fail, particularly after the blowback of the Lehman collapse. And the Fed has gotten over the intellectual and procedural hurdle of letting an investment bank become a bank holding company a when it looks desirable. So hey, just go back to being an investment bank, if you and your buddies screw up the financial system again, the Fed will find some way to rescue you. And they’ll probably be faster about it, since they just have to restart mechanisms they set up in the crisis.

Now the answer is that banks and firms like Goldman (assuming Goldman decided to give up its banking license) is that these systemically important firms will have had to come up with living wills, they will be wound down if they become insolvent.

I’m pretty skeptical of this idea. Goldman and other players active in the debt and OTC derivatives markets have extensive counterparty exposures. Moreover, if one firm was on the brink of failure, it is likely that others are vulnerable too, that the turn of events that led one firm to be in serious trouble has affected others as well.

So you have two risks: that the mechanics of winding down the euthanized firm will be seen as interfering with, and potentially damaging, the operations of its counterparties (how can you hold creditors at bay without freezing positions? How can you let an insolvent company continue to trade? I don’t see clean answers to this problem). Independent of the operational problem of an untested process for winding down a trading firm (which is likely to make counterparties and customers nervous) you have the separate risk of contagion, the fact that one firm has been taken down can lead to a run on others.

Unless I see a great deal more done to solve the problem of connectedness, and I see perilous little here (we’ve discussed the considerable shortcomings of derivatives “reform” in previous posts, and even that inadequate plan may not be passed), one major financial firm going down will still have the potential to jeopardize others.

Let’s use a simple metaphor. Say a real moron designed a bunch of nuclear reactors. Not only do they have the risk of suffering an uncontrolled chain reaction every ten years (aka a meltdown) but when one reactor goes haywire, it has high odds of triggering similar behavior in other reactors.

You have a costly and politically unpopular way of controlling a reactor that looks in danger of going critical but it leaves the faulty reactor in operation. You have a cheaper and untested way that that your engineers devised that might allow you to shut down the reactor if it misbehaves again. But if it doesn’t work, the other reactors will go critical.

Now in a real world situation, what do you think the government will do? Even if the engineers’ plan sounds great, is anybody going to risk a test on an untried approach with so much at stake? The banking industry (remember, it is full of narcissists) is likely to assume not and act as if they have a backstop. Recall that is the biggest danger here, not so much what the government actually does in the next crisis, but what the incumbents believe it will do, since that will affect how much risk they take.

But in a replay of Lehman, the powers that be may feel compelled to take a stand and shut down a troubled firm. And if it goes badly, we’ll be right back to a “no more Lehman/____” policy for the rest of the crisis.

And the amazing confirmation of sorts comes at end of the article:

Goldman declined to comment but executives say that if the Volcker Rule is passed, it would probably sell its deposit-taking bank, which is an insignificant part of Goldman’s $900bn-plus balance sheet.

However, Goldman leaders do not believe they would have to give up the financial holding company status acquired at the height of the 2008 crisis to escape the rule’s ban on in-house trading.

Yves here. So get this: Goldman believes that to escape the Volcker rule, all it has to do is ditch its depositary. It can still keep its bank holding company license, which was granted to make it easier for the Fed to lend to Goldman. It also appears that Goldman will keep its FDIC guaranteed deb outstanding too.

In other words, Goldman will be able to keep the most important bennies of its status of being a bank, that of ready access to a Fed lifeline, as long as it makes an “appease the peasants” disposition of its depositary, in the hope that no one gets what is really going on.

A former Fed staffer wrote me early after the Obama administration started making Volcker the front man for its new banking reform PR campaign, saying “I can’t believe Volcker is allowing himself to be used like this.” I cant’ fathom it either, but it certainly looks like that is what is happening.

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    1. Doug T

      Powell played the fool on WMD, but willingly? He claims not. (“If I had known then…”) Sadly, he did the same with his ringing endorsement of Obama—a lot to live down.

      I’ll take Yves word for it that Volcker’s rule is so porous. Perhaps he is too out of touch to realize he’s being used as a chump or fall guy.

    2. Anonymous Jones

      It’s perfect that yours is the first comment, because Powell was the first person who came to mind reading this post. Regarding Doug’s response, I simply cannot fathom that Powell didn’t know what he was doing. He was doing it because of threats/blackmail or because he had no spine. If I had a good inkling everything he was saying was untrue (based on reading the reports of others on the ground), I can’t imagine he didn’t know. That said, I guess anything is possible.

      I’m totally agnostic about Volcker’s knowledge. He may really believe this or he may be willing to say he believes this to achieve a greater goal. Who knows?

  1. MichaelC

    GS Capital Markets is the CDS counterparty to many of the CDS at the heart of the AIG/synthetic swap mess (abacus, etc)

    GS Capital Markets is now part of GS Bank US, a NY State Chartered Bank.

    GS’s original depository, the industrial bank, was the entity used to provide it the cover to convert rapidly to a bank. It has been folded into the BUSA entity. At the time of conversion it swept the GS capital Markets, GS Mortgage , and other entities,(For the full list check the feds website) under the safety of the banking umbrella.

    The idea that GS can simply dispose of its “depository” may be true, and entirely insignificant ,but it doesn’t eliminate the bank that was created to house it and the other entities now included in the NYS chartered bank it belongs to. As a result the statement has lttle significance.

    This is GS spin, and I’m shocked you’re not parsing it correctly. The depository piece is in fact a tiny and insignificant bit of GS and perhaps they can chuck it, but who cares at this point, its served its pupose

    And of course they will not have to give up the Fin holding co status.

    Two separate, true, but unrelated statements.

    They cannot easily give up the banking license given the entities merged into the banks. Volcker’s got them where he wants them. Prop rules on their CDS portfolios fall under the Volcker rule.

    Goldman’s not giving up its banking license. All the CDS deals at the other banks are done at out of their banking entities.

    1. Yves Smith Post author


      I am not at all certain this is as significant as you believe it to be. I will check with some banking experts, but I would think if push came to shove, Goldman could find a way to back to back the CDS into another entity, a non-US bank if needed.

      1. MichaelC


        I had a look at the 4q09 call report for GS Bank USA

        The bank (GS Bank USA) reported 4.3b profit for 4Q09 based on call report.

        GS group consolidated reported a 4.79b 4q09 profit.

        Caution: Income reported for the call and for the consolidated financials are not directly comparable,the accounting methodology differences are beyond the scope of this note.

        Of special note from the bank’s statement, Net Income is mostly from trading income of +6b int rate, -3.5b fx and +2.2b from credit trading.

        Consolidated GS income is booked on various entities, so it’d be reckless to conclude all GS income comes from the bank without analysing the other units. For example, equity trading isn’t done at the bank.

        We can safely conclude, I think, that the bank is a not trivial part of GS given the trading profits reported on the Call Rpt.

      1. MichaelC


        Apologies for clogging your comments section, but since accountants are at least as clever as politicians and PR spinsters, and since I think this is significant, I won’t apologize for asking you and your readers to consider the implications of the acounting arbitrage angle in this story.

        The GS accountants calculated the cost/benefits of housing the riskiest (to GS) assets in a protected entity (GS Bank USA) and determined they should be booked where they can benefit the most from FDIC guarantees.

        If the crap is safely loaded on the banks books and explicitly backstopped, then what is left in the “investment bank” to worry about? (Plenty, I’m sure, but perhaps not as much as you fear, I think)

        I may be wrong, and my faith in Volcker’s vision may be unwarranted, but we should consider that the most systemically risky activity is now under the control of the Fed. Volcker’s contempt for the SEC is in the public record, so it’s not a stretch to think he wants to leave the least risky bits to the SEC and their equally icompetent peers.

        Legitimate underwriting (with realistic ratings) is reasonably low risk activity that will be permissable at banks under the Volcker plan. Capital market debt financing will not disappear if ratings agency credibility can be restored for that segment. There’s a reasonable expectation that can be accomplished.

        Equities (and program and HFT trading) are not housed in the banking entity. Those risks bear scrutiny, but they don’t contribute much to the interconnectedness risks we’re most concerned with.

  2. Richard Kline

    I don’t like ‘living wills.’ Like many things, they may work for small firms, but there are too many interconnections and swaps which go band in the night with large firms. I like ‘seize, purge, sell.’

    The Chinese have a solution for master capitalists who screw up to the detriment of ‘the system.’ It’s small caliber, surgically located, and they bill the recipient’s estate. I like that solution, too.

  3. MichaelC

    GS Capital Markets, the CDS counterparty involved in the synthetic CDos (abacus et al) is now part of GS bank usa (BUSA). I’m not sure, but I think most of their derivaives activities are dealt through this entity.

    The original utah depository (an industrial bank I believe) was the entity that provided the cover for the feds to move so quickly. GS capital markets, the depository, GS mortgage (and others see fed listing for full list)were all folded into the NY chartered bank (BUSA)

    Its true they could chuck the depository, but they’re still left with a regulated bank that houses their CDS business. And also true, of course they would not have to (or want to) give up their FHC designation.

    Its unlikely any of the businesses will ‘just go back to being investment banks”. They’re caught in Volcker’s trap.

    To draw any of the conclusions you’ve made in the post you need to investigate the entities that make up goldamn sachs in total before drawing any sweeping conclusions.

  4. killben

    Now the answer is that banks and firms like Goldman (assuming Goldman decided to give up its banking license) is that these systemically important firms will have had to come up with living wills, they will be wound down if they become insolvent.

    I’m pretty skeptical of this idea.

    Exactly. If this is allowed to happen, then the risk stands curtailed as high risks could blow-up in your face and thus will act as a deterrent.

    So how do you achieve it in practice? END THE FED Or at the very least KICK “THE MORAL HAZARD” to Princeton University to pick up the threads of Great Depression. If anyone in the country deserves a trashing it is this guy!!!

  5. NYT

    Surely the ongoing access to cheap Fed funds is the real perk here, the Fed lifeline is just a bonus.
    In 2008, GS paid about US$31.5B in interest on borrowings of US$515B. In 2009 they paid just US$6.5B interest on borrowings of US$533B – an interest rate of 1.2%. Pretty extraordinary borrowing rate for such a highly leveraged company which flirted with bankruptcy in 2008.

    1. DownSouth

      One has to wonder how much money Goldman could borrow, and at what rates, if it had to hit the streets rattling its tin cup.

      One also has to wonder about the quality of collateral Goldman posts to borrow its $533 billion.

      Would Goldman even be solvent, much less profitable, if it didn’t have the chump US taxpayers backing it up with massive subsidies?

      1. Doug T

        Indeed. GS became a bank overnight to get free money bennies from Benny. If I change my charter tonight, can I get a no-interest mortgage tomorrow? Is there any paperwork involved? I’d gladly pay you Tuesday.

  6. Roy L. Manns

    Lehman brothers was allowed to fail IMHO as it was a thorn in the foot of Goldman, Sachs, JPmorgan and others as it took away a lot of their business and made them lower their fees. Henry Paulson’s brother was one of their senior officers in the Chicago office.

    I agree if you want to to do horse trading on the side or go to dog fights give up your ” holier than though” banking and even Investment Bank license. The real money GS, JPM, MS and others make is in the trading rooms, the rest is just a front.

    Then they insure their bets with the likes of AIG and it was all that trading bets and credit default swaps that almost sank the nation.

  7. Dan Duncan

    Volker needs to recognize, Goldman’s M.O. is Adapt and Exploit.

    Really, Volker needs to suck it up, get Middlebrow for an evening, and suffer through a Blue Man Group “performance”…and there he will find the Secret of Goldman. For Goldman Group is to finance what the Blue Man Group is to percussion.

    Work with me for a moment here, please:

    Cut to the basement of some industrial warehouse. The lighting is dim and it has a blueish hue to it. Polybutylene pipes form a network of veins pumping who knows what to who knows where.

    Enter a trio of analysts in tight black clothing with faces wearing a coat of blue paint over latex bald caps. The cobalt freaks survey the scene in a state of collective wonder.

    Out of the blue, one of them finds a wrench and holds it aloft with rapt curiosity. He considers the possibilities.

    Quickly, he employs his new tool and goes to work on those polybutylene pipes. His cohorts assist him.

    In a case of astonishing mastery–for someone who just found a fucking wrench for the first time– the coolant colored hominid extricates several pipes from the network and distributed them to his fellow Indigo Boys.

    Each now stares at his pipe. And is aroused…while considering the possibilities.

    Then, one of them starts a two-count beat of the pipe against the wall. Another follows suit, but on the floor. Finally, the third finds his rhythm on an old table. Before long, they find their synchronicity….

    It turns out that each is a percussive savant capable of teasing out rhythmic percussion from veritable smortgasborg of idiosyncratic instruments. It’s as if the drumming trinity of Keith Moon, John Bonham and Neil Pert got together for an epic jam session in the basement of an abandoned warehouse.

    Cut now to the basement of a West Texas refinery. The lighting is dim and it has a goldish hue to it. Pipes are everywhere…veins of carbon slurp: “Oil that is. Texas Tea. Black gold. Well the first thing you know, ‘ol Lloyd’s a Trillionaire.”

    Enter a trio of analysts, each in a blue-blood Brooks Brothers suit and a coat of gold paint over faces ensconced in latex bald caps. It’s a Freak Show, Investment Banker Style.

    One of them finds a gauge and another finds a large, circular nozzle with four spokes. The last is reading a manual he found on the table. Before long, they turn the nozzle hard to the left, the gauge skyrockets (along with the price of oil), and Gold Man Group starts wailing on the empty pipes in a tri-parte rhythm that is so far beyond the Forever Blue Freaks…that the Blue Boys end up looking like they have the rhythmic soul of 3 US Senators dancing at their post-election parties.

    And that is the essence Goldman…and there’s nothing anyone can do about it. Ever.

    1. Doug Terpstra

      Polybutylene pipes are the perfect plumbing for a house of cards. Within a few years they explode just like derivatives causing extensive structural damage.

  8. John Doe

    Living wills are contracts and contracts can be broken. For GS any contract is made to be broken for a profit.

    Now a constitutional amendment is another thing. There is enough populist anger out in the country yet (but fading fast) to push through an amendment to never ever again give government money to a bank. They must be allowed to exist in a ‘free market’ capitalist system i.e. fail if they ingest a poison.

    Constitutional amendment beats Volcker ‘rule’.

  9. DaveM

    Financial Holding Companies and Bank Holding Companies are separate categories under Gramm-Leach-Bliley. There’s no necessary reason Goldman would have to give up the FHC designation in order not to fall under the Volcker rule. (Insurance companies are or are owned by FHC’s, for example.) Goldman converted to a Bank Holding Company in September 2008 but later converted to a Financial Holding Company. (Prior to that it was an SEC-regulated consolidated entity, a category which only existed so that investment banks would fulfill the reuirements of foreign regulators; it had little real function under US law.) You would not necessarily expect a Volcker rule to apply to FHC’s as a class. Whether one could be a BHC and not own a bank is more interesting question (to which I don’t immediately know the answer).

  10. run75441


    “Say a real moron” . . . would this be opposed to a “fake moron?” :)

    I think you do morons (an out of date psychological term) an injustice as they lack the cognitive ability to understand or know why they do certain things due to low intelligence. A better word to use woould be criminal since GS understood exactly what they were doing by their speculative habits then and the same as they do now.

    1. Doug T

      Well, she might have used Rahm Emanuel’s term “fucking retards” that he used for progressive organizers.

  11. Siggy

    Much of what Volker is offering up is appealing. What is needed is legislation that reestablishes the God Given Right of every entrepreneur and enterprise to fail. That’s the objective.

    Is Volker an administration stalking horse? Quite possibly.

    If forced to choose, would Goldman drop the bank or the trading desk? At this point, I think it would be the bank. Their next adaptation will be to go smaller and to make a clear split into a corp and a partnership. The partnership will be very conservative and the corp will be very speculative.

  12. rita

    Maybe instead of the “Volcker Rule” we can have the “Goldman Rule” which would be to devise a system of regulations and regulators that would address all of the possible exceptions to the prudential management of financial institutions that the clever folks at GS can come up with. In other words the government needs to stay one step ahead of GS not two steps behind.

    The Volcker Rule should only be one aspect of a much more comprehensive solution to the loss of taxpayer money resulting from bailouts of private companies.

  13. Carlos Comesana

    Instead a temporary nationalization my preferred formula to clean the USA financial market is: Reinstall Glass Steagall, have all commercial banks sell their investment activities and all investment banks their deposits. Any investment bank that during the crisis was – for its convenience – transformed into a commercial bank and now wants to return to be an investment bank should be charged for the help received to weather the crisis. Specifically, all past bonus and dividends should be charged a 100% fine or claw back. Provide FDIC coverage and FED rediscount facilities only to commercial banks which should execute the traditional “boring” activities while maintaining limited and under strick control the proprietary trading. Build up an specific robust reserve at the Fed out of the gross income of the investments banks activities and let them go under if they get into unsoluble troubles. For the purpose of promoting competition and to avoid the existence of entities “too big to fail” in addition to the normal restrictions applied to comercial banks (FED,SEC,FDIC,Basel,etc.) a mandatory cap should be fixed on all commercial banks liabilities including the contingent. Public rescue shouldn’t be an alternative for other financial entities.

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  14. Wayne Jett

    Is it not logical that, if Goldman Sachs spins off its bank depositary subsidiary, the remaining entity no longer qualifies as a bank holding company. On the other hand, if it continues to qualify as a bank holding company, then it must abide by the Volcker rule which prevents proprietary trading.

    The only reason GS can assert its “easy choice” is because its monstrous influence over the federal government makes its every utterance a “can do” proposition for Treasury, the Fed, the White House and Congress.

    1. Yves Smith Post author


      What you argue as “not logical” appears to permissible, according to the FT, although it is way too early to tell for certain, since the Administration had yet to put forward any legislation.

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