Wednesday, July 21, 2010

Goldman Sachs and Market Volatility

News from the corporate earnings front illustrates why the financial reform bill (which President Obama will sign today) is needed. The bill includes a fairly strong version of the Volcker rule, named for former Federal Reserve chairman Paul Volcker, which limits the of banks to trade on their own accounts. In other words, a firm can either be a bank or a hedge fund, but not both.

The New York Times reports that Goldman Sachs, which pioneered the practice of trading for its own account, reported that
its quarterly earnings were hurt by poor results from its trading desk:
Goldman’s traders have long aroused envy across Wall Street for their ability to prosper in markets good and bad, but they lost the Midas touch in the spring, especially when it came to trading stocks. As clients bet on rising volatility, Goldman took the other side of the trade, leaving it on the losing end when volatility did in fact surge.
The market has been unusually volatile this year. The S&P 500 has moved up or down 1 percent or more six times in the last month. Goldman is a component of the S&P 500, so its share prices, which climbed or fell 1 percent or more ten times in the last month, contribute to the current volatility. Goldman was not even a publicly traded company until 1999, when the partnership structure was scrapped and shares were publicly traded for the first time. The purpose of the IPO was to raise capital for the firm's trading desk. The net effect is that Goldman's trading activity amplifies the market's volatility.

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