Goldman Sachs Actually Read the Volcker Rule

Why would it make sense to let banks hold 100 percent of a thing, but not 99 percent?

Davos Lloyd's beard is even better than mine.

Photographer: Jason Alden/Bloomberg

Okay here's a chart of how the Volcker Rule works:

not to scale

That chart is nonsense, which is partly my fault -- don't go trade on it or anything -- but mostly the fault of the Volcker Rule. Basically, if you're a bank, you can buy assets using your own money -- "proprietary" trading or investing -- if you either plan to hold them for more than 60 days, or plan to get rid of them quickly to satisfy "reasonably expected near term demands of clients, customers or counterparties." But you can't buy assets using a fund that contains some of your money and some of your customers' money -- that's a "hedge fund" or a "private equity fund." Unless no more than 3 percent of the money in the fund is yours. Then you're fine. 1

The chart is weird and stripey but don't complain to me about it, I just made the chart, not the rule.

I've talked about Goldman Sachs's Volckerishness before, because it delights me. 2  And it continues to delight. Here is a story about how "Goldman has been quietly coming up with several new ways to put its own money to work in formats that appear to stay on the right side of Volcker," which is very easy to understand if you just keep that chart in front of you. Goldman is investing its own money, not clients' funds, so it's at the top of the chart. And it's buying things like "apartments in Spain, a mall in Utah and a European ink company, all of which the bank hopes eventually to sell for a profit," but not (one assumes) within 60 days, so it's toward the right of the chart. Top right is green. Good to go.

That is the whole analysis, but obviously you can complicate it further if you want. I mean, that chart is ludicrous, which annoys the people who ... well ... who made the chart:

Goldman’s merchant banking business is upsetting some regulators, who worry that such investments do not follow the spirit of the law, which aims to reduce concentrated risks at banks, according to people at three regulatory agencies, who were not authorized to speak publicly.

GUYS YOU WROTE THE RULE. There is no "spirit"! If the Volcker Rule "aims to reduce concentrated risks at banks," then those green bits of the chart are a map of where it misses its aim. 3  It seems odd to get upset at Goldman for that.

There are arguments for turning the top right of the chart red, and arguments for leaving it green. 4  The best argument for change is probably just the patchy appearance of that chart: Why would it make sense to let banks hold 100 percent of a thing, but not 99 percent? If private equity is too risky for banks, why would increasing their exposure to it make them less risky? 5  That's not necessarily an argument for banning merchant banking. It could be an argument against prohibiting bank-run private equity funds. Something about that boundary doesn't look right though.

The real joy in the story, though, comes when Goldman leaves the map behind. Notice what happened here:

In the second half of 2014, Goldman spent about $800 million with two partners for 144 hotels in Britain, and $200 million with two different partners on the South Towne Center mall in Sandy, Utah, among other large investments.

That's not just Goldman investing its own money in hotels and malls. That's Goldman investing a mix of its own money and its "partners'" money in hotels and malls. That ... I mean, if you just dumbly look at my chart, that looks like the big red middle zone. Goldman doesn't own 100 percent of those malls or hotels, though I bet it owns more than 3 percent.

But it's fine. Goldman doesn't actually have to own 100 percent of the businesses it invests in. It can partner up with other people to buy those businesses. It just can't invest anyone else's money. It can't sign clients up for a fund, and then decide how to invest the fund. But it can decide how to invest its own money, and then sign clients up to invest alongside it.

That's kind of a tricky distinction, isn't it? You can't quite re-create a private equity fund that way, but you can get close. You invest some money, your clients invest some money, you share the risks and the upside, you get paid for putting the deal together. (Presumably Goldman's "partners" in those deals aren't paying private-equity-like fees, but there's no rule against Goldman getting better economics for sourcing or structuring deals. 6 ) You have to put a new joint venture together for every deal, instead of having one big fund with one set of partners, and you're limited in the number of partners you can bring into any deal. In some ways this is nice -- you get to pick and choose the right partners for each deal, instead of investing everyone's money indiscriminately -- though it lacks the long-term committed capital, and recurring fees, of a true private equity fund. But if you do it enough, it does sort of start to look like a private equity business.

The Volcker Rule recognizes this: One key factor in distinguishing an allowable "joint venture" from a banned "private equity fund" is whether or not the thing holds itself out as being a private equity fund. 7  Which makes sense. You can't draw the distinction between what's allowed by the Volcker Rule, and what isn't, on substance. The substance of the rule is in that chart, which just isn't very substantial. Technicalities are really all you have to go on.

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  1. The best place for non-nonsense charts about this is Davis Polk's The "Proprietary Trading Flowcharts" tell you how to think about proprietary trading. The 60-day stuff is in the "Purpose Test" on Step 1C of that flowchart ("A rebuttable presumption that a trade is for a trading account arises if the banking entity: holds the instrument for fewer than 60 days ..."); the anticipated-demand stuff is in Step 2A-1 ("... designed not to exceed, on an ongoing basis, the reasonably expected near term demands of clients, customers or counterparties ..."). That last quote about near term demands is taken from section 4(b)(2)(ii) of the Volcker Rule, page 13 here.

    The "Hedge/PE Fund Flowcharts" tell you how to think about funds. The exemption for 100 percent ownership is on slide 15 ("Wholly Owned Subsidiary"); slides 16 and 17 ("Joint Venture" and "Acquisition Vehicle") are, for practical purposes, of even greater interest. The exemption for 3 percent ownership is on slide 27 ("3% Per Fund Limit: Asset Management Exemption").

    Obviously my chart is very approximate and semi-parodic! Particularly, the left side of the top of the chart is very schematic and shouldn't be taken literally. The green part shouldn't be all green (a very short-term proprietary non-market-making strategy would violate the Volcker Rule), and the red part shouldn't be all red (a market-making strategy that held securities for 59 days would be fine), and holding periods are not a good way of separating them, but you get the idea.

    Also the 100 percent stuff is not quite right; there are mechanics about allowing some small investments by employees, etc., alongside the bank's own capital.

    Also a bunch of other stuff is glossed over. If you want to actually understand the rule, go read Davis Polk's charts, or, I mean, you could read the rule, why not.

  2. The usual disclosure: I used to work at Goldman Sachs, and still own a little restricted stock (though not for long, so I have near-term incentives for the stock to be up!). Also when I last wrote about Goldman's Volcker tricksiness I called them "a squid after my own heart" and made a joke about them re-hiring me based on my own Volcker tricksiness.

  3. I mean, whatever, this is a stretch for the metaphor. Arguably the green bit at the bottom isn't a miss, since owning less than 3 percent of something perhaps isn't a "concentrated risk," I don't know.

  4. From the DealBook article, here's an argument for turning the top right red:

    A Federal Reserve governor, Daniel K. Tarullo, noted at a Senate hearing in November that banks had been prohibited from engaging in commerce, like owning companies outright. He said that it would probably be good to go back to such a divide. “Nothing that I have observed in my time teaching in this area, writing in this area, and in the almost six years on the Fed has changed my view that fundamentally it’s been a sound principle, and there’s no particular reason to digress from it,” Mr. Tarullo said.

    And for keeping it green:

    A spokesman for Goldman said in a statement: “Banks are in the business of providing promising businesses with the capital they need to grow. Sometimes that means offering a loan and other times making an equity investment. We are proud to invest alongside our clients in industries that create jobs and promote economic growth including major infrastructure projects, clean energy and technology companies and cutting-edge health care businesses. We ensure our investments comply with all regulations, including the Volcker Rule.”


  5. I once made a halfhearted effort to answer that question:

    The counterargument goes something like: managing outside private equity capital is a very profitable capital-light business, since you get 2 and 20 or whatever on a big pool of off-balance-sheet money, with no downside risks. Managing your own merchant banking investments is not; you just get the profits on whatever you can do profitably, and the losses on whatever you can’t. So “running private equity” is more attractive, and at scale, than “making private equity investments.” So you’ll do, like, 10x as much of it, if you can, and you’ll make riskier investments since you share a lot more of the profits than you do of the losses. And since LPs in bank private equity funds demand that the bank have skin in the game via a substantial co-investment, you’ll end up running a $10X fund with $3X of your own money instead of an $X fund with $X of your own money, while also making riskier investments.

    I think that, as a description of bank riskiness, that is not insane. But it's hard to imagine that it actually motivated the drafters of the Volcker Rule in drawing the distinction. 

  6. If it did. For all I know the clients came to Goldman and asked it to co-invest. The DealBook article, though, notes that Goldman's merchant banking has "caused disquiet among some of Goldman’s big clients, who complain privately that the bank is supposed to help its clients buy companies and other assets but instead ends up competing for those assets."

  7. Section 10(c)(3) of the Volcker Rule exempts a "joint venture" with no more than 10 unaffiliated co-venturers that "is not, and does not hold itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in securities for resale or other disposition or otherwise trading in securities." (See also slide 16 of the Davis Polk fund charts.)

To contact the author on this story:
Matt Levine at

To contact the editor on this story:
Zara Kessler at

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