How Goldman Quickly Found The Volcker Rule Loopholes

The ink on the final Volcker Rule has not dried yet, and already the TBTF armies of lawyers have found all the loopholes in the rule they need to continue prop trading as if nothing has changed. Enter Goldman Sachs which as the WSJ reported, is raising a new fund, to which it will contribute 20% in capital, which will make investments in commercial real estate-backed loans including office buildings, hotels, and shopping centers. "Goldman has raised more than $1 billion for the new fund, according to people briefed on the matter. The fund aims to boost that total to $2 billion, and Goldman expects to invest "up to 20% of total equity commitments," according to September marketing documents reviewed by The Wall Street Journal." Just how did Goldman get the green light to allocated up to $400 million for what is clearly a prop trading bet: "because regulators excluded many real-estate loans from the tough restrictions on investment funds, allowing Wall Street firms to continue making concentrated bets—sometimes risky ones—with their own capital." In other words, when it comes to reflating the precious real estate bubble, anything goes.

The details from the WSJ:

Goldman also is making direct investments in real-estate assets, according to people familiar with the matter. Last year, it formed a partnership to purchase and upgrade a Chicago office building.

 

Both forays appear to navigate around new regulations mandated by the Volcker rule, a provision designed to limit how big banks risk their own capital in pursuit of profits from trading securities and investing in hedge funds and private equity.

 

"There's no way you're going to write enough rules to outlaw every conceivable type of risky investment a bank might make," said Michael Mayo, an analyst with CLSA Americas. "There's a balance between making sure banks don't blow themselves up and allowing them to take enough risks to help facilitate economic growth."

 

The new fund's focus on real-estate loans, and its status under previous U.S. investment-company laws, leaves it outside the Volcker rule's definition of hedge funds and private-equity funds, according to the rule and people familiar with Goldman's fund. The rule did compel Goldman to change the fund's name, removing the reference to "GS" that appears in a predecessor real-estate debt fund. Now it is called Broad Street Real Estate Credit Partners II, a nod to Goldman's former headquarters at 85 Broad Street.

Of course, that is not the only Volcker loophole Goldman has found:

In September 2011, it joined forces with investors to buy a portfolio of distressed property loans from a unit of Popular Inc., BPOP +0.79% one of Puerto Rico's largest banks, for about $173 million, or less than half the unpaid principal balance of the loans, according to Popular.

 

Goldman told investors in marketing documents in September that there is a big opportunity in real-estate lending, citing in fund documents an estimated $1.4 trillion of commercial-real-estate debt set to mature over the next five years. It said there are fewer real-estate lenders than in past years, and that remaining active lenders have a "lower risk tolerance."

 

The firm also said loans in the first real-estate fund average $121 million, which the documents say are "in excess of competitors and provide a competitive advantage."

 

As for Goldman's direct real-estate investments, people familiar with the firm's thinking said it held its direct debt and stock investments for a long enough time to avoid the label of "proprietary trading," an activity the Volcker rule limits.

So... held to maturity prop trading? Worked miracles for Zions. But don't worry: loans, unlike other securities, apparently don't go down in value and thus can be exempted from all regulation.

Let's hope this time Goldman times the commercial RE bubble well: the last time around things didn't work out quite as expected:

Goldman jumped into property investing in the 1990s, buying up distressed loans during the savings-and-loan crisis. Its Whitehall real-estate fund group raised billions of dollars over the years and made splashy equity investments, such as buying Manhattan's Rockefeller Center in 1996.

 

During the crisis, Whitehall wrote down big losses following top-of-the-market property deals like the Stratosphere, a Las Vegas casino.

 

In an investor letter this September, Whitehall said the equity value of its $4 billion fund that closed in 2007 had been marked down by 59%. That is Goldman's estimated value of the fund, about 41 cents on the dollar, as reported to its investors.

That's ok though: the very well connected hedge fund that is Goldman Sachs is insured by the FDIC. Probably thanks to all those Goldman ATMs strewn around the country...