How one Goldman Sachs trader made more than $100m
One junk-bond trader at Goldman Sachs earned more than $100 million in trading profits for the firm earlier this year, an unusual gain at a time when new regulations have pushed Wall Street to take fewer risks.
The gains were the work of Tom Malafronte, a managing director on the bank’s high-yield-bond desk in New York. The 34-year-old trader bought billions of dollars in junk corporate debt on the cheap starting in January, then locked in profits as prices recovered, according to people familiar with the matter.
The windfall is a throwback to a previous era on Wall Street, when big banks were more eager to step in as markets turned and bond traders took bigger risks. Those bets have become less common since the crisis. Hoping to make the financial system safer, the USCongress passed rules that curbed banks’ ability to wager with their own money and required them to hold more capital.
Wall Street responded by shutting down its proprietary-trading desks and shrinking inventories of securities like bonds. The government allowed banks to continue trading securities in their capacity as market makers, serving as intermediaries between buyers and sellers. Regulators have said banks must show that the amount of bonds and other securities they hold on their balance sheets don’t exceed what they need to meet “reasonably expected near-term demand”.
As a market-maker, Malafronte bought the bonds from clients anxious to sell them and ultimately lined up other investors to buy them – at a higher price. Goldman profited from the difference, people familiar with the matter said.
It is difficult – if not impossible – to define clearly the difference between trades made to meet clients’ demands and those conducted just to make money, said Hal Scott, a professor withHarvard Law School who has testified before Congress about efforts to regulate the banking industry.
“No one has been able to distinguish between market-making and prop trading,” Scott said.
Critics have argued that the post-crisis rules on trading have made it harder for the biggest Wall Street banks to buy bonds from investors in times of stress and hold them until markets calm.
Malafronte’s haul lands squarely in the centre of a debate about the role of banks, which are eager to show that they’re putting clients’ interests ahead of their own while at the same time scrambling to capitalise on a dwindling number of profit-making opportunities.
The prospect of profits remains an important incentive in market-making, encouraging banks to step in when markets turn rocky. Their appetite for bonds in volatile times can limit the size of price swings.
Wall Street banks have less room to manoeuvre than before. Notable profits or losses on trades often provoke a more detailed conversation with the Federal Reserve or other regulators.
Goldman also imposes daily risk limits on its traders, who can exceed them under certain market conditions if the firm’s executives and risk managers allow it.
It is unknown if regulators scrutinised Malafronte’s trades, or if the trades had exceeded his risk limits.
As a bank trader, Malafronte is a member of a Wall Street fellowship in decline.
He specialises in trading bonds issued by companies that have moved in or out of investment grade, a rating accorded to relatively creditworthy firms. When a company loses its investment-grade rating, its bonds are deemed high-yield or “junk”.
Even though banks are taking fewer risks and making less money from their securities businesses, old-fashioned traders are still needed to match buyers and sellers in less-liquid markets.
Jeff Bahl, who headed Goldman’s high-yield trading desk and worked with Malafronte before leaving to work with his father at Cincinnati money manager Bahl & Gaynor Investment Counsel, said: “Tom is a tremendous risk-taker. In any opaque market, such as high-yield, the value of a skilled risk-taker will always be there.”
Malafronte didn’t return calls seeking comment, and Goldman spokespeople declined to make him available for an interview.
Malafronte began by buying bonds issued by Freeport-McMoRan and Teck Resources, two mining companies that endured debt-rating downgrades earlier this year. He also snapped up debt issued by retailer Toys “R” Us, Gymboree Corp and Avon Products, along with a handful of other companies, as investors’ appetite for riskier securities nose-dived early in 2016, people familiar with the matter said. Concerns about an economic slowdown in China and the US, falling commodities prices and the uncertain direction of interest rates were roiling global markets.
On certain days in that period, Malafronte accounted for more than a third of all trading volume in some bonds, the people said.
Malafronte unloaded some bonds within a day of buying them as bond prices rebounded on higher oil prices and better economic data, the people said. In other instances, Goldman held the bonds for weeks. By the end of June, Malafronte had locked in profits of more than $100 million for Goldman over several months, the people said.
Like all big banks, Goldman takes fewer chances than it did before the financial crisis. Goldman’s daily value-at-risk, a measure banks use to determine how much their traders stand to lose in one day, averaged $72 million during the first quarter of 2016 and $62 million in the second. In 2007, before the crisis, it was above $120 million per quarter.
Goldman traders, collectively, made more than $100 million on just three days during the first quarter and six days during the second, according to regulatory filings.
“It goes against everything we’ve been seeing the last three years,” Thomas Hearden, senior trader at hedge-fund firm Skylands Capital, said when he was told about Malafronte’s trades.
Malafronte’s trades were a rare positive during a tough stretch for Goldman’s securities business.
The firm’s fixed-income, currency and commodities arm, where Malafronte works, had revenues of $3.59 billion during the first half of 2016, down from $4.74 billion in the same period a year earlier.
Goldman’s FICC results improved in the third quarter, with revenues jumping 34% to $1.96 billion.
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This story was first published by The Wall Street Journal