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Back to the future

10 December 2014 By Antony Currie

Billy Salomon has passed away at 100 just as the trading era he ushered in is returning. As boss of his father’s eponymous firm in the 1960s and 1970s, he turned Salomon Brothers from a U.S. Treasuries shop into, among other things, a bonds powerhouse. All the while, though, he kept a handle on risk and an eye on what was best for the client.

Wall Street soon twisted that model into proprietary trading desks that eventually helped seed the 2007-2009 crash. John Gutfreund, his successor at Salomon Brothers, waited three years before making the most obvious break with the past: he took the partnership public by selling it to commodity trader Phibro in 1981 for $557 million. That enraged Salomon, who said of Gutfreund, “His materialism is disgraceful,” according to Michael Lewis’ book, “Liar’s Poker.”

That sparked Wall Street’s quarter-century on-again, off-again love affair with prop trading. Financial market crises would occasionally dim investment banks’ interest in putting their own – or increasingly their shareholders’ – capital at risk. Salomon Brothers’ infamous Treasury rigging scandal in 1991, for example, required a bailout from minority shareholder Warren Buffett. Goldman Sachs trading desks, meanwhile, almost sank the firm in 1994.

But the strategy always returned in some form. And by last decade it proliferated at much larger and more systemically important banks. Citi, for example, absorbed Salomon Brothers via Travelers in 1998.

Prop desks may have had little to do directly with the 2008 financial crisis, but the culture of playing fast and loose with other people’s money did. That’s what prompted firms from Citi to Merrill Lynch to park dodgy mortgage CDOs on their books, causing tens of billions of dollars in losses.

Regulatory changes, from the Volcker Rule to capital requirements, have effectively killed much of those risky businesses. Hedge funds and others have tried to pick up some of it, with limited success. Earlier this year, KKR closed the equities prop business it acquired from Goldman. And Occidental is shuttering the oil trading business it bought from Citi: the remnants of Phibro, which helped kick off the changes 25 years ago.

Wall Street trading still has problems, from bond market illiquidity to market rigging scandals. But it’s slowly returning to the less risky business that was Billy Salomon’s style.

 

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