It seems that Goldman executives have been advising analysts from other companies that they don’t expect the new financial regulations to cut into their profits in any meaningful way. A key passage in the story:
More recently, however, top Goldman executives privately advised analysts that the bank did not expect the reform measure to cost it any revenue.
“The statement was perhaps surprising in its level of conviction,”
Bank of America
Merrill Lynch analyst Guy Moszkowski wrote in a note to clients, “but we’ve learned to take such judgments from GS very seriously.”
The story is a bit confusing because it also quotes some sources as saying that banks like Goldman are seriously preparing for some major changes, the biggest of those being the reshuffling of personnel that would take those people engaged in proprietary trading (i.e. trading for the bank’s own account) and put them in other departments, most likely trading on behalf of clients.
The new rules will bar banks like Goldman from engaging in prop trading – the concept of this rule is that federally-insured depository institutions shouldn’t also be engaging in high-risk speculation – but there are a number of loopholes/exceptions to the rule that will allow the bank to continue gambling as before. Among other things the banks will be allowed to put aside a certain amount of money to sponsor hedge funds and will also be allowed to engage in some prop trading in separately-capitalized subsidiaries.
The LAT story suggests that banks like Goldman have either figured out how to compensate for their lost prop trading revenue, or else they’ve figured out a way to keep doing what they have been doing, only in some other form.
The other part of the new law that was supposedly going to hurt the banks was a new requirement that all derivatives be traded and cleared on open exchanges. Up until now banks like Goldman had a massive advantage in the derivatives market because they had more information about pricing than their customers, thanks to the market being in the dark instead of on open exchanges.
The situation in the derivatives market was very much like the football-betting business would be if the spreads for the games were not published. If the Vegas lines weren’t published in the papers, who do you think would better know the spread – a big Vegas bookmaker, or U the individual bettor? If the House knows that ten thousand gamblers think the Ravens are on average seven points better than the Bengals, will you know you’re being cheated when they offer you four and a half points to take Cincy?
That’s what it was like in the derivatives market, where customers like Greece and Jefferson County and the Denver school system didn’t know what the real price should be for products like interest rate swaps – and banks like JP Morgan and Goldman did know, and were able to gouge customers accordingly.
There was supposed to be a big change after this law, which supposedly would force the market onto exchanges. Things supposedly would be like the NYSE, where everyone, not just the high-volume traders, knows the price of IBM or Ford shares. When the bill passed, the sources I talked to almost unanimously identified this one section as the most meaningful part of the new law.
But I’ve been hearing that the clearing/exchange-trading requirement is not as solid as some thought it might be. In particular some critics are saying that the clearing requirement may be problematic
because the banks have tremendous influence over clearing-houses like the Intercontinental Exchange (ICE) and the Chicago Mercantile Exchange (CME). But this LAT
story also suggests that the banks are not concerned with that section of the bill. To quote:
The law, signed by President Obama in July, could force the trading of derivatives, a big business line for Goldman, onto exchanges. Regulators might allow the trading of some contracts over the counter but require that the resulting payments be handled by a clearinghouse.
Either way, “we think we are well positioned to be a market leader under the new rules,” said Jack McCabe, co-head of Goldman’s derivatives clearing service business.
Richard Bove, a bank analyst at
Securities, said he had changed his view of the law’s effect on Goldman.
“I thought this company was going to be really harmed by this bill; now I’ve figured out that it’s not going to happen,” he said. “They should win big here.”
There are a lot of unknowns about how this is all going to play out, but it’s certainly interesting that the people who should know best about how all of this is going to work appeared to have made a judgment already.
PS – After a call from the metaphor police I had to amend this post a little. I was trying to describe a situation where the real line was Baltimore -7 and the bettor gets offered Cincy plus just four and a half. Sorry for the confusion.