Michael Lewis Muses That A "Scarcity of Suckers" Is Behind Big Banks' Dropping Prop Trading

With his usual wit and insight, Michael Lewis asks in a BusinessWeek column today what's really behind Goldman Sachs', JPMorgan Chase's and Morgan Stanley's migration away from proprietary trading, shortly after winning the right to continue trading for their own accounts?

Although a ban on proprietary trading was proposed for the Dodd-Frank financial reform bill, banks won the right to invest up to 3 percent of their capital in their own internal hedge funds, which could be used as prop trading desks. Yet Morgan Stanley, JPMorgan Chase, and Goldman Sachs all have plans to close their proprietary trading units or to sell their interests in the hedge funds they control. "Something is wrong with this picture," Lewis writes. "Why fight for a right, and win, only to proceed as if you have lost? Why take prisoners only to surrender to them?"

To see Wall Street turn its back on money is as unsettling as watching a shark's fin veer away, and then sink from view. It leaves you wanting to know where the shark has gone, and why. None of the firms have offered a good explanation for their new and seemingly improved behavior, but it's not hard to think up several.

Lewis offers three possible explanations. Least plausible, in his view, is that the large firms have decided to play nice. His second scenario: that the firms "have looked anew at proprietary trading and have seen a dying business," due to lack of interest in large, risky trading positions, brought on partly by government investigations. "At the bottom of this new trend lies a deeper problem: a scarcity of suckers," Lewis says.

The proprietary trading business turns in part on one's ability to find the fool-to find people willing to take the stupid side of the smart bets you are placing. One of the side effects of our seemingly endless financial crisis is to wash a lot of fools, many of them German, out of the game. It's as if a casino owner awakened one morning to find the tourists had all gone, and the only remaining patrons were pros counting cards.

Lewis' third hypothesis is that the big banks aren't abandoning proprietary trading at all, they're just moving trades for their own books into customer-facing trading desks.

After all, you don't need a proprietary trading desk to engage in the two activities that any proprietary trading ban would seek to prevent: 1) running huge trading risks; and 2) taking the other side of the customers' stupid trades. Goldman Sachs' infamous Abacus program-the one that talked AIG into selling vast amounts of cheap insurance to offset subprime mortgage risk, and then shorted the instruments they themselves had created-was not dreamed up by the prop trading desk. It was the brainchild of what customers knew as the "Client Facing Group."

Lewis points out that the real reason banks appear to be walking away from their most profitable line of work may never come out because of the veil of secrecy that continues to cover this part of the financial world.

What's really striking is how little ability the outside world retains to find out what is going on inside these places-even after we have learned that what we don't know about them can kill us. Yet news of the death of the Wall Street prop trader has been greeted with hardly a peep. And I wonder: Is this the nature of our financial world going forward? Big decisions, in which the public has a clear interest, being made outside public view, with little public discussion or understanding. If so, it isn't a future at all. It's just the past, repeating itself.