Prop Trading

Topline bloodbath Summary: Net revenues in Investment Banking were $781 million, 33% lower than the third quarter of 2010 and 46% lower than the second quarter of 2011. Net revenues in Financial Advisory were $523 million, up slightly from the third quarter of 2010. Net revenues in the firm’s Underwriting business were $258 million, 61% lower than the third quarter of 2010. Net revenues in both equity underwriting and debt underwriting were significantly lower than the third quarter of 2010, reflecting a significant decline in industry-wide activity. The firm’s investment banking transaction backlog increased compared with the end of the second quarter of 2011. Net revenues in Institutional Client Services were $4.06 billion, 13% lower than the third quarter of 2010 and 16% higher than the second quarter of 2011. Net revenues in Fixed Income, Currency and Commodities Client Execution were $1.73 billion, 36% lower than the third quarter of 2010. And so on. As for the number everyone in #OWS is looking for, "The accrual for compensation and benefits expenses (including salaries, estimated year-end discretionary compensation, amortization of equity awards and other items such as benefits) was $1.58 billion for the third quarter of 2011, a 59% decline compared with the third quarter of 2010. The ratio of compensation and benefits to net revenues for the first nine mo nths of 2011 was 44.0%. Total staff levels decreased 4% compared with the end of the second quarter of 2011." In a nutshell: for the first time in probably since the Lehman crisis, Goldman reported a massive loss in its prop trading division of $2.5 billion, and also based on LTM accured comp benefits and the total staff at period end of 34,200, average compensation amounted to $358,713/employee.

We have long noted that Goldman's feigned change of heart to eliminate its prop desk is nothing but a sham, as the very same traders will continue pursuing principal strategies but merely be given the additional layer of protection that they are "client facing" i.e., make fake flow markets. Today, Michael Lewis confirms this speculation, and identifies precisely how not only Goldman, but all banks are abusing Frank Dodd using legalistic loopholes that do nothing at all to change the actual role of the principal trader, whose existence has always been predicated upon accumulating positions primarily in OTC products (nobody makes money trading stocks any more) and selling when the firm so desires.

BN  10:03 *GOLDMAN SACHS SAID TO PLAN TO CLOSE PROPRIETARY TRADING UNIT
BN  10:03 *GOLDMAN PRINCIPAL STRATEGIES TRADERS IN NY MAY JOIN OTHER FIRM
BN  10:03 *GOLDMAN PRINCIPAL STRATEGIES HEAD SZE MAY START A HEDGE FUND

So as long as you do one flow trade a year, you are considered a flow trader? Brilliant.

So JPMorgan fires 20 people in its commodity prop book. What about Sempra Energy, which Dimon purchased recently? Is that getting spun off too? Or are all the 20 whopping newly unemployed advised to seek employment at Sempra? One wonders why JP Morgan named a new global head of commodity strategy today. But yes, let's wave the white flag in the face of the dumb public and pretend we are complying with Volcker. But first, let's have the corpulent Frank in charge of the finreg abortion lisp something on TV about what a great success his capture by Wall Street is proving to be.

As regular readers know too well, a long-running peeve for Zero Hedge has been Goldman's purported ability to take advantage of its huge monopoly in flow trading to the benefit of its prop positions. In fact, Zero Hedge has engaged in direct communication with Goldman in the past on numerous occasions, in which we have alleged that Goldman's prop desk is bad, and Goldman, logically, took the opposite side. We have just learned that Goldman, according to CNBC, is preparing to spin off its entire prop trading division. We consider this a huge victory for capital markets, if indeed this rumor is true, and a huge loss for Goldman, which contrary to representations by Messrs. Viniar, van Praag and others, probably generates well over 50% of its revenue courtesy of some form of interaction with its prop desk. This is a small but critical start to fixing the improprieties of a leaking Chinese Wall" flow-vs-prop problem, that has allowed a two-tiered market to flourish over the past several years.

John Taylor is his usual painfully forthright, objective and candid self in this must read Capital.de interview in which he analyzes the prospects before Europe (not good), and compares the Euro to a "chicken, with a severed head running across the yard before it dies." Taylor believes that so long as Europe continues to exist in its make believe monetary never-never land, any efforts to bring some form of fiscal rationality in the form of austerity, will be underminded by the continuing lies on the monetary and financial stability fronts. This fits in with Roubini's recent admonition that Obama should finally start treating Americans as adults. Yet in light of recent evidence that Obama has taken more vacation time and golf breaks than even his predecessor, any chance for him to be taken seriously may be long gone. Furthermore, Taylor notes that instead of the ECB demonizing FX traders like himself, the bureaucrats should be thanking him, as he is one of the few voices of reason, and just like in the Asian crisis of 1997, those who listen to him ultimately prevent major capital losses (kinda like what ZH suggested to those invested in Greek bonds some time ago, to the utimate chagrin of an overly defensive RBS). Yet the most notable observation to us at least, is that Taylor confirms our previous statement that Goldman is lying about the contribution of prop trading to its top line. Of Godman's revenue, Taylor says: "80 percent of the revenues which now come from proprietary trading of the bank. No matter what happens, Goldman Sachs always profits." Compare this to our statement from December 2009: "Goldman's head of PR claims the Goldman's prop trading accounts for
only 12% of net revenue. Zero Hedge disagrees, and we would like to
pose a question to Mr. van Praag which we hope Goldman will answer for
us in order to refute our observation that Goldman may be disingenuous
in its public statements." Goldman's subsequent response to us did nothing to refute our allegation: "We’ve said publicly that prop trading represents approximately 10% of this year’s reported net revenue.  We generate the vast majority of our revenue in FICC by facilitating trading activity for our clients and nearly all our revenues in FICC are “due to capital at risk” (your phrase)." Shortly after this exchange, finally bringing due attention to Goldman's prop trading operations, the Volcker Rule appeared, and all else equal, will likely impose major restrictions on Goldman's top line, which could be as big as an 80% cut.

Bloomberg reports: "Goldman Sachs Group Inc., the securities firm that makes about 10 percent of its revenue from trades on its own behalf, is ceasing proprietary trading in one type of structured debt, according to a person close to the firm." A stunning development, which could be a watershed event for the banks to-date relentless refusal to budge on the issue of prop trading, better known as taxpayer/discount window backstopped gambling. CLO prop today. All prop tomorrow?

An interesting observation from NYSE's Duncan Niederauer, who is convinced that "separating prop trading, from market making business, from customer facilitation businesses, from principal business" will be next to impossible. For those not on Duncan's side of the trade, we are hopeful that Paul Volcker is just as aware of all this and much more. Although should Obama's proposal be defanged by Geithner's intellectual challenged henchmen when it goes through the Treasury for implementation, Duncan may just be on to something, thus precluding Obama's lofty goal to actually moderate the taxpayer funded risk-taking activities at banks. As is well-known, Niederauer is well-connected within the political circles of DC, where his opinion on what is proper for capital markets carries abnormal sway, so one may wonder, was Obama aware of this all along and was once again merely stringing the morts along, in his epic and unrelenting journey from one TV appearance to another.

Recently Goldman Sachs has been attempting to downplay the impact of prop trading on its operations, with various executives, among them both Lloyd Blankfein and David Viniar, claiming that proprietary trading accounts for a mere 10% of total revenue. This is likely a major misrepresentation and a substantial underestimation of the true impact of prop trading to the firm if an earlier analysis by third party credit analysis firm CreditSights is correct. According to CS analysts, Goldman's true prop exposure is at least 30% and probably inbetween 30% and 40%. This would imply that the proposed ban will have a truly material impact on Goldman, much more so than Goldman's executives claim.

With everyone in arms over the prop trading ban, the simplest question has so far evaded the broader population: just what does the administration define as "prop trading." And, as Bernstein points out, will the loophole needed to not crash the bond market be large enough to render the entire proposal moot: "Bernstein would guess that the wording of "operations unrelated to serving customers" in the Administration's release may be related to primary dealers in government bonds that must take on market risk to remain profitable when dealing with clients in the Treasury market. With virtually no bid-offer spread, proprietary trading exemption would be necessary for the government desks. But we find it hard to believe that the new proposals are meant to allow unlimited risk taking in high yield, derivatives and emerging markets desks as these desks make a market for its clients. Unfortunately, at this point, nobody knows exactly what the limitation, or even the definition, will be."

Is Obama's best policy to date a mere farce to replenish political capital ahead of midterms?

If you accept situations such as AIG and other cases where Buy Side investors (and, indirectly, the US taxpayer) were defrauded through the use of OTC derivatives and/or structured assets as the archetype “problems” that require a public policy response, then the Volcker Rule does not address the problem. The basic issue that still has not been addressed by Congress and most federal regulators (other than the FDIC with its proposed rule on bank securitizations) is how to fix the markets for OTC derivatives and structured finance vehicles.

"Separating core banking franchise from speculative activities, imposing tighter leverage requirements and examining the complicated relationships between high frequency traders and banks constitute critical steps toward ensuring our financial markets are strong and stable.

By adopting these common-sense proposals, we can go a long way toward stabilizing our economy, restoring confidence in our markets and protecting the American people from a future bailout.

America cannot afford another financial meltdown and the American people are looking to Congress to ensure that that does not happen." - Ted Kaufman

11:37 01/21 OBAMA BAN WOULD PREVENT BANKS OWNING,INVEST IN HEDGE/EQ FNDS

11:37 01/21 OBAMA PROPOSING RULE LIMIT COMM BANKS FROM PROP TRADING

11:37 01/21 SR ADMIN OFFL:BAN ON PROP TRADE ALSO APPLY TO BANK HOLDING COS>

11:37 01/21 ADMIN OFFL:WANT REGULATORS TO BE REQUIRED TO STOP PROP TRADING

It appears that prop trading could soon be on its way out. Luckily, it only accounted for "just over" 10% of Goldman's revenue: it will therefore likely not be missed. Bloomberg writes: "President Barack Obama tomorrow will offer new proposals on limiting the size and complexity of proprietary trading systems as a way to reduce risk-taking, a senior administration official said." While this is not yet the formal end of prop trading which may or may not be a legal way to take advantage of the commingling between flow and prop trading, thus scalping clients in a perfectly acceptable manner (define the word "acceptable"), it has all the makings of the beginning of the end. And, much more importantly, this marks the long-awaited beginning of Glass-Steagall's return.