a follow up
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Wall Street Proprietary Trading Goes Under Cover: Michael Lewis
2010-10-27 01:00:00.0 GMT
Commentary by Michael Lewis
Oct. 27 (Bloomberg) -- A few weeks ago we asked a simple
question: Why are the same Wall Street banks that lobbied so
hard to dilute the passages in the Dodd-Frank financial overhaul
bill banning proprietary trading now jettisoning their
proprietary trading groups, without so much as a whimper?
The law directs regulators to study the prop trading ban
for another 15 months before deciding how to enforce it: why is
Wall Street caving now?
The many answers offered by Wall Street insiders in
response boil down to a simple sentence: The banks have no
intention of ceasing their prop trading. They are merely
disguising the activity, by giving it some other name.
A former employee of JPMorgan, for instance, wrote to say
that the unit he recently worked for, called the Chief
Investment Office, advertised itself largely as a hedging
operation but was in fact making massive bets with JPMorgan's
capital. And it would of course continue to do so. JPMorgan
didn't respond to a request for comment.
The fullest explanation came from a former Lehman Brothers
corporate bond salesman named Robert Wosnitzer, who is now at
New York University, writing a dissertation on the history of
proprietary trading. He's been interviewing Wall Street bond
traders, he said, and they have been surprisingly open about
their intentions to exploit one obvious loophole in the new law.
The innocent eye might have trouble spotting this loophole.
The Dodd-Frank bill bans proprietary trading (Page 245: "Unless
otherwise provided in this section, a banking entity shall not
engage in proprietary trading") and then appears to make it
clear what that means (Page 565: "The term 'proprietary
trading' means the act of a (big Wall Street bank) investing as
a principal in securities, commodities, derivatives, hedge
funds, private equity firms, or such other financial products or
entities as the comptroller general may determine").
Invitation for Abuse
The big invitation for abuse, Wosnitzer says, lies in the
phrase "as a principal." It falls to the comptroller general -
- or, more specifically, the General Accountability Office,
which is overseen by the comptroller general -- to determine
precisely what the phrase means.
And, at the moment, the GAO pretty clearly hasn't the first
clue. ("We're really too early in the process to speak to how
we might define it," said spokeswoman Orice Williams Brown.)
Never mind: Wall Street is busily defining the term for
itself.
Make an Argument
"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.
Of course, there is all sorts of flawed logic here, but the
point is that...there are a hundred different ways to claim to
be acting as an agent or for a customer.''
This ambiguity is no doubt one reason the financial reform
bill passed in the first place. Even its clearest prohibitions
are couched in language inviting Wall Street to evade them.
But the new game of cat and mouse raises a simple, even
naive question: Why do these giant Wall Street firms want so
badly to make huge bets with their shareholders' capital?
Save Us
After all, the point of the ban on proprietary trading is
as much to save the banks from themselves as to save us from
them. We have just come through a period where putatively shrewd
individual bond traders lost not millions but billions of
dollars for their firms, by making really stupid bets.
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.
Yet Wall Street's biggest firms apparently still badly want
their traders to be allowed to roll the bones. Why?
What They Do
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.'"
Keep It Simple
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.
(Michael Lewis, most recently author of the best-selling
"The Big Short," is a columnist for Bloomberg News. The
opinions expressed are his own.)
For Related News and Information:
For more Lewis column: NI LEWIS <GO>
For more commentary: OPED <GO>
For more top financial news: FTOP <GO>
--Editors: Marty Schenker, James Greiff.
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Michael Lewis at mlewis1@bloomberg.net
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