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Goldman Sachs and the Next New Thing on Wall Street

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It's official. Goldman Sachs has inaugurated the second stage of Wall Street's development after Dodd-Frank and the Volcker Rule.

The first post-reform stage was the transformation of proprietary trading units into market-making trading units.

Before Volcker, Wall Street firms risked their own capital trading securities with counterparties. After Volcker, Wall Street firms risked their own capital trading securities in anticipation and reaction to customer order flow. The old way was to ask: "how can we make money by reacting to market events?" The new way is to ask: "how can we make money by reacting to customer reactions to market events?"

See the difference? In the old way, you had counterparties. In the new way, you focus on customers. And those two words—counterparty and customer—are totally spelled differently despite beginning with the same letter.

Officially, this was the "getting rid of things we aren't allowed to have anymore" stage. Hedge funds, private equity funds, prop trading outfits. Goldman was a big leader in shedding the stuff they figured was taboo even before the final rules were written.

And now we've entered the next stage. The "building new things that we think we can have" stage. In this stage, Wall Street firms will attempt to do things that are a lot like what they used to do—but in new ways, using new kinds of legal loopholes because the old ones were sewn shut with Volcker thread.

Goldman is once again taking the lead in this business.


Ordinary folks will think this means Wall Street is getting around the Volcker Rule. But that's why they are so ordinary. On Wall Street this is called "compliance."

The new thing Goldman is going to start doing is running a credit fund for wealthy customers that will invest in the unrated debt of mid-sized companies. This will replace the old thing Goldman did to run a credit fund for wealthy customers that wanted to invest in risky debt.

The old things at Goldman were called "hedge funds." The new thing is called a "business-development company."

Actually, business-development companies—or BDC if you want to sound knowing—aren't really all that new. They've been around for decades. They just weren't all that attractive to investment banks who could run hedge funds, which were less regulated.

Goldman's new business-development company will be called "Goldman Sachs Liberty Harbor Capital LLC"—probably because the guy who came up with this idea has an office that looks out at the Statue of Liberty in New York Harbor. It will sell shares to investors in a private placement. Liberty Harbor will then borrow money to enhance its ability to buy up loads of debt that has never been rated by a credit-rating agency.

The managers of GS Liberty Harbor LLC—let's call it GoSaLiHa, pronounced "Go Sell It Ha!"— are a bunch of guys—and, maybe, some gals, but this is Wall Street so, you know, probably not—who went over to Goldman after their old hedge fund, Amaranth Advisors, imploded back in 2006.

You will have to try not to confuse GoSaLiHa with a hedge fund run by these same people called Liberty Harbor, which is part of Goldman Sachs's asset-management group. Liberty Harbor manages about $5 billion in assets, according to a fund prospectus. That was one of the old things Goldman did. And, although it's still doing this thing because the Volcker prohibitions are phased in over eternity, eventually Goldman's desire to run the fund without being able to own a major part of it will diminish.

Ominously, when GoSaLiHa was first uncovered by Reuter's Matt Goldstein back in January, it was run by Greg Felton. He has since left Goldman. No one knows why. It will now be run by Raanan Agus, the co-head of Goldman Sachs Investment Partners, which is another hedge fund run by Goldman.

But please remember: This isn't a hedge fund! Or a private equity company!

There are many things a hedge fund or private-equity company could theoretically do that a BDC cannot do. The law limits the amount of debt a BDC can take on to an amount equal to its equity. BDCs cannot have single positions that are larger than 25 percent of their portfolio. Most importantly, they are also required to have most percent of their assets in privately issued securities of private companies not listed on any national exchange.

But they can also do things that hedge funds could not. Like take in investors who aren't super wealthy. Investors do not need to meet the income, net worth or sophistication criteria imposed on private-equity investment. So these things can be sold to ordinary investors—although that certainly is not Goldman's plan. It has too many extraordinary investors to even think about selling to ordinary folk.

Bonus regulatory compliance: Goldman said in its public filings that this BDC will also count as an "emerging-growth company" under Jumpstart Our Business Startups Act of 2012. This means it can take advantage of reduced reporting rules meant to encourage tech start-ups to go public. So none of those pesky Sarbanes-Oxley audited internal controls requirements. And if Goldman were to IPO this thing, the bank doing the underwriting could produce research reports touting it.

What does it mean to have a credit fund that counts as a start-up for disclosure and a business development company run by Wall Street's premier investment bank? No one really knows.

As far as I can tell, no one ever contemplated what would happen if someone put hedge-fund managers specializing in risky credit in charge of a BDC that is also a Jobs Act emerging-growth company. Or, at least, no one who wasn't at Goldman Sachs ever did.

But what could go wrong?

Follow me on Twitter @Carney

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