Michael Lewis Exposes Goldman's Prop Trading In Flow Clothing

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.

From Michael Lewis in Bloomberg today:

One trader I interviewed,” Wosnitzer says, “said that from here on out, if he wants to take a proprietary position in a credit, he will argue that he bought the position because a customer wanted to sell the position, and he was providing liquidity; and in order to keep the trade on, he would merely offer the bonds 10 basis points higher than the offered side, so that he will in effect never get lifted out of the position, while being able to say that he is offering the bonds for sale to clients, but no one wants ‘em. When the trade finally gets to where he wants it -- i.e., either realizing full profit, or slaughtered by losses -- he will then sell it on the bid side, and move on.

In other words, this is nothing less than prop trading masking as flow. Period. The problem is that as this does nothing to address the issue that the TBTFs are once again taking on massive risk in the form of huge principal inventory accumulation. Furthermore, due to the quirks of VaR reporting, this will actually have an impact of reducing reported VaR, even at a time when Morgan Stanley recently reported its highest blended VaR in history. In other words, the TBTFs, in their avoidance of Donk, have become even greater timebombs than ever imagined. And that banks will crash is certain:

Even before the crisis there was never any reason to think that traders at big Wall Street firms had any special ability to gamble in the financial markets. Anyone with a talent for investing is unlikely to waste it on Morgan Stanley or Bank of America; he’ll use it for himself, or for some hedge fund, which allows him to keep more of his returns.

And if this were true before the financial crisis it is even more true after it, when trading inside a big Wall Street bank will be less pleasant and more fraught with politics.

Why do banks persist in abusing risk to this level, and demand to be bailed out even though they know full well they are not equipped to deal with the resultant fall out? Here is Lewis' take.

One answer -- which Wosnitzer points to -- is that this is what Wall Street firms now mainly do. Beginning in the mid- 1980s, the Wall Street investment bank, seeing less and less profit in the mere servicing of customers, ceased to organize itself around its customers’ needs, and began to build itself around its own big and often abstruse gambles.

The outsized gains (and losses), the huge individual paychecks, the growing ability of traders to bounce from firm to firm from one year to the next, the tolerance for complexity that doubles as opacity: all of the signature traits of modern Wall Street follows from the willingness of the big firms to allow small groups of traders to make giant bets with shareholders’ capital, which the shareholders themselves don’t and can’t understand.

The new way of life began at Salomon Brothers in the early 1980s, right after it turned itself from a partnership into a publicly traded corporation; but it soon spread to the others.

‘‘That was the particular moment when a new culture of finance crystallizes,” Wosnitzer says. “And it restructures all of finance. All of a sudden it’s ‘I made X, pay me X minus Y or, screw you, I’m leaving.’”

Zero Hedge completely agrees with Lewis recommendation on what should be done to ban prop trading. Of course, because it is the right thing to do, and not the corrupt version of pretend-action, so diligently enforced by the arguably most corrupt duo of politicians to ever grace D.C., it will never get enacted until long after the next market crash, and subsequent systemic reset.

There’s a simple, straightforward way for the GAO to construe the Dodd-Frank language, and it would reform Wall Street in a single stroke: to ban any sort of position-taking at the giant publicly owned banks. To say, simply: You are no longer allowed to make bets in the same stocks and bonds that you are selling to investors.

If that means that Goldman Sachs is no longer allowed to make markets in corporate bonds, so be it. You can be Charles Schwab, and advise investors; or you can be Citadel, and run trading positions. But if you are Citadel you will be privately owned. And if you blow up your firm, you will blow up yourself in the bargain.

Amen.