How A Departing Goldman Sachs Insider Made The Case For The Volcker Rule

Goldman Sachs executive director Greg Smith became a former Goldman Sachs executive director this morning after he penned a resignation letter in the New York Times that confirmed virtually every negative characterization of the bank. Smith slammed the “toxic and destructive” Goldman environment, in which directors referred to their clients as “muppets” and traders worried not about the interests of clients but about the size of their profits.

In the editorial, Smith described how Goldman’s thirst for profits at all costs developed:

How did we get here? The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm…you will be promoted into a position of influence.

What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

Perhaps unintentionally, Smith’s editorial made a compelling case for the Volcker Rule, an element of the Dodd-Frank Wall Street Reform Act that would prohibit proprietary trading at federally-backstopped institutions. Banks like Goldman, which made billions of dollars by making “shitty deals” that sold mortgage-backed securities and other complex derivative products to unwitting customers then turned to taxpayers for a bailout when too many of those deals went sour, would no longer be able to make those trades without giving up access to the Federal Reserve’s emergency lending and the FDIC’s backing. (Remember, Goldman converted into a bank holding company at the height of the financial crisis, in order to access the Fed’s emergency lending programs.)

Predictably, the banking industry opposes the Volcker Rule and has spent the last two years trying to kill it. Bank lobbyists were able to water down the rule before it even became law and, since it passed, have attempted to make it even weaker, arguing that it will have substantial costs for the American economy.

In reality, the Volcker Rule shifts risky proprietary trading to actual investment firms, hedge funds, and other “small-enough-to-fail” institutions that, unlike banks, don’t have the backing of the federal government. That will undoubtedly make banks like Goldman Sachs smaller and less profitable. But as Smith made clear today, that’s not necessarily a bad thing.