Michael Lewis on the Case of Goldman's Missing Traders

In the runup to the vote on the financial reform bill, the big Wall Street banks squashed an attempt by Senator Carl Levin (D-Mich.) to pass a simple ban on any form of proprietary trading. The final version of the financial reform bill restricts proprietary trading but allows big Wall Street firms to invest up to 3 percent of their capital in their own internal hedge funds. How exactly the new rules are enforced is left to regulators inside the Federal Reserve, but it's not hard to see how a wholly owned hedge fund might become a proprietary trading group, with a different name. The 3 percent loophole amounted to an invitation for the big banks to keep on doing at least some of what they had been doing—which is why Levin felt compelled to remove it, and the banks fought so hard to keep it.

Yet in the past few weeks news has leaked that Morgan Stanley (MS), JPMorgan Chase (JPM), and Goldman Sachs (GS) all intend either to close their proprietary trading units or to sell their interests in the hedge funds they control. Something is wrong with this picture. Why fight for a right, and win, only to proceed as if you have lost? Why take prisoners only to surrender to them? Having preserved their loophole, the big American banks now appear to be freely abandoning any attempt to exploit it. (Credit Suisse (CS), meanwhile, just bought a stake in a hedge fund.)

To see Wall Street turn its back on money is as unsettling as watching a shark's fin veer away, and then sink from view. It leaves you wanting to know where the shark has gone, and why. None of the firms have offered a good explanation for their new and seemingly improved behavior, but it's not hard to think up several. From least plausible to most:

1) Having not merely preserved but bolstered their place at the heart of capitalism—with little banks failing everywhere, the big keep getting bigger and stronger—the major Wall Street firms have experienced an epiphany about their relationship to the wider society. They don't need to screw people! In a smaller and less competitive financial industry, it will pay to be the nice guy, and so Goldman Sachs now wants to play nice.

2) The big Wall Street firms have looked anew at proprietary trading and have seen a dying business. For a start, their proprietary traders, put off by subpoenas and government inquiries and the new internal aversion to short-term pain on big trading positions, are fleeing for the privacy of hedge funds. But the exodus of trading talent is only part of the problem. A general malaise has come over the world of big-time financial risk taking. Everywhere you look, hedge funds are either closing or shedding employees or, most shockingly, cutting their fees. At the bottom of this new trend lies a deeper problem: a scarcity of suckers.

The proprietary trading business turns in part on one's ability to find the fool—to find people willing to take the stupid side of the smart bets you are placing. One of the side effects of our seemingly endless financial crisis is to wash a lot of fools, many of them German, out of the game. It's as if a casino owner awakened one morning to find the tourists had all gone, and the only remaining patrons were pros counting cards.

Prop trading isn't what it used to be. At the same time it's a far greater nuisance than it ever was. It's not worth the trouble to prop trade, unless you can prop trade in some wholly novel way. Which brings us to a third explanation:

3) Goldman Sachs and Morgan Stanley and JPMorgan Chase are not abandoning proprietary trading. They are just giving it a different name, for appearance's sake. They are dismantling the units called "proprietary trading" and shifting the activity onto trading desks that deal directly with customers. (Which would explain why so few "prop traders" are being let go.) After all, you don't need a proprietary trading desk to engage in the two activities that any proprietary trading ban would seek to prevent: 1) running huge trading risks; and 2) taking the other side of the customers' stupid trades. Goldman Sachs' infamous Abacus program—the one that talked AIG into selling vast amounts of cheap insurance to offset subprime mortgage risk, and then shorted the instruments they themselves had created—was not dreamed up by the prop trading desk. It was the brainchild of what customers knew as the "Client Facing Group."

In short, there are any number of explanations why Wall Street firms are all at once letting it be known they intend simply to walk away from what has been, until very recently, their single most lucrative line of work. The answer could be none of the above or some mixture of the three. But what's really striking is how little ability the outside world retains to find out what is going on inside these places—even after we have learned that what we don't know about them can kill us. Yet news of the death of the Wall Street prop trader has been greeted with hardly a peep. And I wonder: Is this the nature of our financial world going forward? Big decisions, in which the public has a clear interest, being made outside public view, with little public discussion or understanding. If so, it isn't a future at all. It's just the past, repeating itself.

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