Goldman Sachs and Morgan Stanley may shed the "bank holding company" classification in order to skirt the Volcker rule banning propriety trading with the firm’s own capital, according to Susquehanna Financial Group analyst David Hilder.
Goldman and Morgan Stanley both became bank-holding companies during the 2008 financial crisis in order to be eligible for emergency Fed lending. But the new rule, which would limit trading when the bank's own money is a risk, would deal a major blow to one of Wall Street's most profitable businesses.
“The regulators have proposed a massive new compliance burden on banks to prove that their market-making activities are just that and not proprietary trading in disguise,” wrote Hilder in a note to clients. “There will be large additional costs imposed on banks as market-makers that will not apply to market-makers not owned by banks. We would expect that to draw capital to non-bank market-makers, and cause Goldman Sachs and Morgan Stanley to examine whether it makes sense for them to exit the banking system.”
The Dodd-Frank act provision named for former Fed Chief Paul Volcker was released Tuesday in a rather lengthy form by the Fed and the FDIC for public comment. The Securities and Exchange also agreed Wednesday to put the new rules out for public comment.
“Only in Washington could a simple idea—ban banks that accept insured deposits from short term trading for their own account—become a proposal that runs to 298 pages and asks for comments on 394 specific questions,” wrote Hilder. “We would add to positions in positive-rated names that could potentially exit the banking system, GS and MS.”
Goldman Sachs spokesman Lucas van Praag told CNBC that "we have no plans to change our status." Morgan Stanley declined to comment.
Any exit would draw the ire of everyone from legislators to the Occupy Wall Street crowd. Both Goldman and Morgan Stanley changed their status during the height of the financial crisis following the collapse of Lehman Brothers in Sept. 2008 in order to get access to emergency funds not provided for non-commercial banks.
The Federal Reserve rushed through these applications on a Sunday, saying in a statement that in order “to provide increased liquidity support to these firms as they transition to managing their funding within a bank holding company structure, the Federal Reserve Board authorized the Federal Reserve Bank of New York to extend credit to the U.S. broker-dealer subsidiaries of Goldman Sachs and Morgan Stanley against all types of collateral that may be pledged at the Federal Reserve's primary credit facility for depository institutions or at the existing Primary Dealer Credit Facility.”
The Volcker rule gained popularity as many critics of the banks believe that the monster, levered proprietary trading done by these institutions helped exasperate the crisis and worked against their clients’ best interest.
Goldman and Morgan Stanley are set to report earnings next week and according to analysts the lack of profitable trading will weigh heavily on these results.
“Given third quarter weakness across trading and investment banking that extended through the end of September, further equity market declines and wider credit spreads we reduce our GS EPS estimate from a 10-cent gain to a 65-cent loss,” wrote Citigroup’s Keith Horowitz on Monday.
The analyst went on to cite “regulatory risk” as one of the factors that could derail a comeback by the shares.
“Goldman operates several businesses including financial and physical commodity trading, private equity or derivatives that could face greater regulation, or in a severe case, require Goldman to divest some business units,” the analyst said.
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