Macaskill on markets: Trump’s top banks set off Volcker rule alarms
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Macaskill on markets: Trump’s top banks set off Volcker rule alarms

Goldman Sachs badly underperformed other US banks in first-quarter fixed income results, setting off a frenzy of speculation about trading positions that could have led to the disappointment.

Illustration: Kevin February

Much of this focused on an assumption that Goldman lets dealers in its securities division assume more risk than rival banks – effectively setting a generous interpretation for itself on how the Volcker rule applies to market-making business lines.

Goldman’s approach to how much leeway it can take in seeking to profit from market making sets an important tone for Wall Street, especially now that company veterans, including former president Gary Cohn, hold senior positions in the Trump administration.

The bank did not suffer a trading disaster in the first quarter. Its fixed income net revenue of $1.69 billion was barely changed from the same quarter last year, as rates income was flat and improved mortgage performance helped to offset much lower revenues in currency trading and commodities, and there was a fall in credit.

Goldman failed to improve on a weak first quarter for fixed income markets in 2016 and presented a stark contrast to its peers’ 2017 year-to-date results, however. 

JPMorgan, the sector leader, announced a 17% increase in fixed income revenue compared with the same period last year; Citigroup was up 19%; Bank of America Merrill Lynch rose 29%; and Morgan Stanley almost doubled its revenue to $1.7 billion.


Being outpaced by Morgan Stanley in absolute revenue terms as well as a percentage increase must have been particularly galling for Goldman’s senior managers.

Morgan Stanley was for many years a fixed income laggard among the big US banks, with a tendency to lurch between over-promising during periods of expansion then making embarrassing cutbacks and replacing management during downturns. 

When Morgan Stanley cut roughly 25% of fixed income staff at the end of 2015, it looked like a decision to accept a diminished presence in the market, but the performance of the division since it was placed under veteran equities managers has been impressive.

The strong recent quarter in fixed income for Morgan Stanley also served to undermine a Goldman excuse for its failure to match results at bigger universal banks such as JPMorgan: a client mix that is reliant on hedge funds and other investors, with less recurring business from corporate customers.

Morgan Stanley, like Goldman, converted to bank holding-company status during the financial crisis of 2008 and moved to diversify into new activities, but the two firms still have comparable client rosters for their markets businesses. 

Goldman’s underperformance was highlighted by the overall risk assumed by the two banks in the first quarter, as well as relative revenue. Morgan Stanley generated more revenue than Goldman in both fixed income and equities, while taking average value at risk (VaR) of $44 million, which was well below Goldman’s average VaR of $64 million.

No one on Wall Street believes that Goldman’s vaunted and generally well-deserved reputation for joined-up risk management simply evaporated in the first quarter of this year. That strongly indicates that the firm took decisions to increase risk in certain sectors that backfired, albeit without generating actual net trading losses.

This is where the issue of Volcker rule compliance in the Trump era comes in.

The impact of the Volcker rule on bank ownership stakes in funds is relatively well established and uncontroversial. Goldman’s incoming chief financial officer Marty Chavez said on the bank’s recent earnings call that it has applied for and received a five-year extension for Volcker rule compliance on its remaining fund holdings, which were around $6 billion at the end of the first quarter, for example.

The practical details of monitoring risk taking within bank market-making businesses are far from settled, however, and could be confused further as the Trump administration decides how to proceed in meeting its pledge to roll back aspects of the 2010 Dodd-Frank legislation that introduced the Volcker rule. 

The speculation surrounding Goldman’s fixed income problems in the first quarter underscored how limited visibility into market making remains. Chavez attributed the poor performance to weak commodity and currency revenues due to low volatility and consequently lower client activity. 

He blamed a decline in credit revenue on the same trend – low credit-spread volatility – while admitting that corporate bond issuance had been healthy in the quarter and spreads had tightened.

This credit conundrum – lower revenues despite the best quarter for debt capital markets issuance in five years and tighter spreads that should have benefited dealers holding routine inventory – led to reports that Goldman may have lost money on speculative positions in high risk bonds and loans in the energy and retailing sectors.

Goldman stuck by its story. “We specifically cited other areas and factors as the primary reasons” for the fixed income division’s underperformance, said spokesman Michael DuVally. “In fact, the distressed desk had a stronger performance this past quarter than during the same period last year.” 

Stark difference

That does not entirely explain the stark difference in results compared with peers such as JPMorgan and Morgan Stanley, which hewed to the same collective line that higher bond issuance and tighter spreads had boosted credit revenues, while acknowledging that low volatility affected some flow markets, especially currencies.

Goldman may have been marching to the beat of its own drum on assuming fixed income risk in the first quarter, but Deutsche Bank was recently penalized by regulators for failure to have proper marching orders in place for Volcker rule adherence.

The Federal Reserve on April 20 fined Deutsche Bank for “gaps in key aspects” of its Volcker rule compliance before March 2016 and said that “the firm failed to properly undertake certain required analyses concerning its permitted market making related activities”. 

Like Goldman, Deutsche Bank has a unique place in the Trump ecosystem. Goldman alumni are Trump’s top choice when it comes to hiring Wall Street veterans for his administration, while Deutsche Bank is the firm with the most extensive direct lending ties to Trump’s own businesses and provides him with private banking services.

The direction of Dodd-Frank reform and regulatory relief for banks remains as uncertain as many other aspects of policy under Trump. The expected nomination of Randy Quarles to succeed Daniel Tarullo in the top bank oversight position at the Federal Reserve has been greeted by many as a sign that cautious reform will be pursued. Quarles is a lawyer and investor who worked in the George W Bush administration and is viewed as a Republican establishment figure. He has expressed reservations about the design of the Volcker rule, however, which may tempt banks to test the boundaries of compliance ahead of any formal regulatory relief.

Conflicting priorities between different officials within the White House and among Congressional Republicans with an interest in financial industry reform might well delay a cogent overhaul of the existing system. 

The recent alarms set off by the actions of the banks closest to Trump over Volcker rule compliance indicate that further volatility and disparity in earnings could be seen well before any overarching changes to regulation.

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