In stark contrast to JPMorgan Chase's (NYS: JPM) recent "hedge" gone very expensively and very publicly awry, behind the scenes the ever-crafty Goldman Sachs (NYS: GS) has been hedging some bets of its own -- shedding investments and trying to position itself for whatever the looming but as yet unfinished Volcker Rule might bring. Here's the scoop, and a reminder of why the much-maligned Goldman Sachs may still be Wall Street's smartest bank -- and even a good bet for your money.
Paul Volcker's contentious child
The so-called "Volcker Rule" is part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress' response to the 2008 financial meltdown. The Volcker Rule itself is the brainchild of former Federal Reserve Chairman Paul A. Volcker. Its primary aim is to stop banks from engaging in "proprietary trading," i.e., using their own money to make trades on their own behalf.
The rule was supposed to be in place this July, but the initial draft proved highly contentious. By the mid-February commenting deadline, regulators had received so many comments -- from those who think the rule isn't tough enough, like consumer-protection groups, to those who think it's too tough, like banks and industry-advocacy groups -- that a final draft has yet to be written.
Bernanke does some hedging of his own
Goldman has already shut down its in-house proprietary trading operations, but as it's currently written, the Volcker Rule also aims to stop banks from having any meaningful investments in hedge funds or private-equity funds. From a draft of the rule itself:
Banks will be required "to reduce or dilute the investment to not more than 3% of total ownership interest of [any] fund."
The aggregate investment in all the investment interests in such funds may not exceed 3% of the Tier 1 capital of the banking organization."
To this end, the Financial Times is reporting that, per a recent Goldman regulatory filing, in the first quarter of 2012 the bank sold $250 million worth of its hedge-fund investments. This brings the bank's total investment in hedge funds down to $3.06 billion. Regarding its private equity holdings, the bank "continues to manage its existing private-equity funds, taking into account the transition period."
The transition period Goldman is referring to is the extra two years the Federal Reserve recently tacked onto the original July 2012 deadline to give banks time to get into full compliance with the Volcker Rule. Of course, given that the Volcker Rule isn't even completed yet, Fed Chairman Ben Bernanke is doing a fine job of hedging his bets.
Can't a master of the universe get a break around here?
Goldman Sachs isn't the only big bank trying to divine what the future will be like under the Volcker Rule. Wall Street peers JPMorgan and Morgan Stanley (NYS: MS) are doing their best to figure it out, too, as are Bank of America (NYS: BAC) and Citigroup (NYS: C) .
Essentially, any bank that happily operated under the old rules is scrambling to find new revenue- and profit-making mechanisms. And bank stocks have been taking it on the chin lately as it is; they really don't need any more obstacles to negotiate. Since late March, Morgan Stanley shares have fallen 36%, while B of A is down 30% and Goldman has lost 24%. In addition, JPMorgan is down 17% just in the past week, while Citi has fallen 20% so far in May alone.
On top of all this, Moody's currently has these five banks, plus 12 others, under review to get anywhere from one- to three-notch credit-rating downgrades. In a worst-case scenario, that could mean no access to the repo market, which some banks depend on for day-to-day solvency, or at the very least that the cost of borrowing in that market could go up, affecting bottom lines.
The death of Goldman has been greatly exaggerated
None of the big investment banks knows exactly what the Volcker Rule will bring, so what to do in times like these? Exactly what CEO Lloyd Blankfein and the folks at Goldman Sachs are doing: being proactive and getting out in front of a changing environment as quickly and intelligently as possible.
And what are investors supposed to do? Keep an open mind that the sector will recover, and keep a close eye on the banks that have done well in the past -- like Goldman Sachs. Chances are, they'll do so again.
While you're waiting to see what becomes of the too-big-to-fail banks stocks like Goldman, check out our special free report and learn about some delightfully straightforward bank stocks, including one Warren Buffett could have loved in his earlier years. The report is titled "The Stocks Only the Smartest Investors Are Buying," and you can download your copy while it's still available.
At the time thisarticle was published Fool contributor John Grgurich is crossing his fingers that Moody's never decides to look too closely at his checking account, and he owns no shares in any of the companies mentioned in this column. Follow John's dispatches from the bloody front lines of capitalism on Twitter, @TMFGrgurich. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of Goldman Sachs and Moody's. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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