Goldman Sachs Bids Its Cash Cow a Fond Farewell

Because of the impending implementation of the Volcker rule, Goldman Sachs (NYSE:GS) will find it much more difficult to derive profits from what has been the firm’s primary cash cow — its lucrative private equity business, which draws in $50 billion annually and reaps huge profits for the bank, its employees, and clients.

For more than 20 years, Goldman Sachs has courted investment business by explaining to clients that the bank and its partners were investing alongside each other. But that enticement will no longer be as useful once the Volcker provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act is finalized later this year.

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The financial crisis prompted President Obama to form the President’s Economic Recovery Advisory Board, headed by former United States Federal Reserve Chairman Paul Volcker. He argued that a functioning commercial banking system was essential to the stability of the entire financial system, and so he proposed that banks be limited in their ability to engage in high-risk speculation. The rule will restrict financial institutions from making speculative investments that do not benefit customers. Therefore, Goldman Sachs will be forced to lower its own investment in its funds to just 3 percent, a decrease from approximately 37 percent…
During the House-Senate conference committee hearings regarding the Volcker proposal, Democratic Michigan Senator Carl Levin described its importance by referencing Goldman Sachs in particular. “We are also pleased that the [proposal] includes strong language to prevent the obscene conflicts of interest revealed in the Permanent Subcommittee on Investigations hearing with Goldman Sachs,” he said. “As the Goldman Sachs investigation showed, business as usual on Wall Street has for too long allowed banks to create instruments which are based on junky assets, then sell them to clients, and bet against their own clients by betting on their failure.”

The result of the investigation he mentioned was a 635-page reported issued in April of 2011 that alleged that Goldman Sachs misled investors and profited from the collapse of the mortgage market. But eventually, the Justice Department decided not to file charges over the firm’s $1.3 billion subprime mortgage portfolio.

Bank of America (NYSE:BAC) will follow Goldman Sachs’s lead. However, instead of shrinking its business, the bank will be exiting the private equity business entirely. Sources told The Wall Street Journal that changes will take place at Citigroup (NYSE:C) as well, where executives are still exploring the bank’s options. It has already cut back the amount of money it invests in hedge funds…
Goldman officials told the Journal that the financial firm remains committed to the private-equity business, saying that the Volcker rule will not “materially” affect its ability to make returns from its investing and lending businesses. Executives did not state specifically how much it earns from the business.

Now the company’s focus is on reassuring clients that its private-equity operations are the same lucrative business they always were.

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