Posted on Saturday, 7th August 2010 by James Martin
Goldman Sachs (GS)
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Shares of Goldman Sachs Group (GS: Charts, News, Offers) jumped one percent yesterday on the news that Goldman Sachs might separate out its proprietary trading or “prop desk” as early as this month. The news was treated as a positive sign from the financial giant after a disappointing second quarter.
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Stock Analysis
Last month, Congress passed the Dodd-Frank Act, also known as the Wall Street Reform Bill. This law is ostensibly written to prevent the type of financial melt-down that our economy and particularly the banking sector experienced in late 2008 and 2009. The legislation contains a provision modeled after some aspects of the Volcker Rule, particularly dealing with the types of trading in which banks can participate while using their own money. The Volcker Rule, originally proposed by American economist and former Federal Reserve Chairman, Paul Volcker is significantly broader than the parts that appear in the new bill, but it is clear that this part of the legislation was strongly influenced by Volcker. Dodd-Frank bans banks from participating in proprietary trading where bank traders actively buy, sell or invest in stocks, bonds, currencies, commodities, derivatives using bank owned money. The problem with this situation is that the bank investments are often in competition with the money entrusted to the bank by customers. This situation can put the bank in a place where there is incentive to act against the best interests of customers.
The language in the Dodd-Frank bill limits bank investments to 3 percent of Tier 1 capital. Currently, Goldman-Sachs is widely recognized as one of the world leaders in proprietary trading with more than $17 billion or 27 percent of its capital invested in this way. Under the new regulations, Goldman-Sachs would have to reduce this amount to $2 billion. Since Dodd-Frank does not require firms to spin off prop desk trading for another four years to seven years, so it is somewhat of a surprise that Goldman-Sachs is considering the move already. Furthermore, two weeks ago, Goldman-Sachs CFO, David Viniar deflected questions about a possible spin off by stating that Goldman Sachs had no definite plans about how it would approach the new legislation: “We believe it is too early at this stage to quantify with any degree of certainty the financial impact of the bill. Any analysis of the current situation relies heavily on a series of broad-based assumptions and in many cases tends to omit the potential offsets like capital release and redeployment, changes to our cost structure, and our ability to react to the new regulations.” The recent announcement of an impending spin off indicates that Goldman Sachs might be facing some pressure to get out in front of the new changes as news recently broke that competitor, Morgan Stanley (MS: Charts, News, Offers) will be spinning off its hedge fund, FrontPoint Partners within the next three months. Goldman-Sachs might also simply believe that if the changes are inevitable, early compliance is the best way to insure profitability in the future.
The news of the spin off comes on the heels of a disappointing 2Q where earnings nose-dived 82 percent. It was Goldman-Sachs’ worst quarterly performance since late 2008 and the first time that the firm missed analyst projections in over five years. The company cited several reasons for the poor performance in the second quarter. The first is a $550 million settlement with the Securities and Exchange Commission in a case where it was alleged that Goldman-Sachs misled investors regarding collateralized debt obligations related to subprime mortgages. The settlement is widely seen as best case scenario for Goldman-Sachs. Another unique item that fell during the second quarter was a special tax of $600 million levied on industry bonuses by Great Britain. Another change coming to Goldman-Sachs is the banning of foul language in company email after congressional hearings heard U.S. Senators publicly reading internal Goldman emails that contained a large number of four letter words.
Investors hope that Goldman-Sachs is back to being focused on business after a tumultuous quarter – and most probably do not care about the kind of language that Goldman-Sachs employees use in email in order to turn a profit.
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