Proprietary Trading Gone Forever or Temporarily Hiding?

     Michael Lewis begins a recent article with, "In the run-up to the vote on the financial overhaul bill, the big Wall Street banks squashed an attempt by Senator Carl Levin to pass a simple ban on any form of proprietary trading." It would appear that the big banks were protecting their freedom; however, Lewis points out that recently "Morgan Stanley, JPMorgan and Goldman Sachs all intend either to close their proprietary trading units or to sell their interests in the hedge funds they control." Which begs the question, why fight to save something you don't plan to utilize? Lewis offers a few ideas, but I believe he avoids another likely possibility. 

     Lewis presents 3 possibilities, starting with the "Nice Guys" theory. Lewis postulates that the big banks have grown fat at the expense of other smaller institutions, which have failed during the crisis, and now they feel a sense of moral remorse for their actions. As such, the big banks have decided to focus more on the client relationships rather just seeking bigger and better profits. Although he dismissing this theory. It would be naive for anyone to assume that a business would make the conscious choice to forgo profits simply for better client relationships. I would argue that if immediate profits are pushed aside through greater client focus, than the firm must be expecting this to establish a competitive advantage and generate greater future profits. 

     Lack of Value is Lewis' second theory for the decline in prop trading. He cites the changed macroeconomic environment as a challenge for traders to find parties to take the other side of their trade. In other words, the current environment has caused a decrease in the number of ignorant parties with which to trade the losing side of a trade, therefore, the big banks are closing up their prop shops. 

     The big banks are not abandoning their prop desks, but rather they are changing their technical name or location. Lewis states that it is possible that the firms are doing this in the hopes that the regulators will not pry into their newly renamed prop shops. I believe that Lewis may have hit it close when he discusses this third theory. Deception is a very useful tactic in the boardroom and the battlefield.

     It is very possible that the big banks are temporarily cutting back on proprietary trading and shifting these resources to newly named devisions and companies with the intent to shift focus away from prop trading to other areas of the banking industry and economy. The advantage to waiting and avoiding attention is two fold; (1) people will forget about the profits made while the country was undergoing difficulty, and, (2) the regulators may forget or be pushed away from the proprietary trading issue onto other areas in need of regulation. At the end of the day, it is possible that a quick deception by the banks could lead to fairly lax regulation of prop trading. Therefore, once the dust has settled and main street and the media are focused elsewhere, the banks can easily ramp up their proprietary trading operations.

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Lewis's article can be found at Bloomberg: http://www.bloomberg.com/news/2010-09-30/mystery-of-disappearing-proprietary-traders-commentary-by-michael-lewis.html

Michael Lewis is the author of The Big Short: Inside the Doomsday Machine, a fast paced look into the world of securitization and those who saw the insanity of the housing bubble. I would recommend this book for finance students, professionals and anyone interested in another side of the bubble; it is  also an easy read. 

Investopedia.com defines Proprietary Trading as "the firm has decided to profit from the market rather than from commissions from processing trades."