Goldman Sachs’ Exit From Market Making Sending A Signal

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After purchasing a traditional market making firm as part of a larger acquisition for $5.4 billion in 2000, a major investment bank is now attempting to sell it for a significant loss at nearly $30 million.

Goldman Sachs Group inc (NYSE:GS) is negotiating with Dutch-based IMC Financial Markets to shed its NYSE floor-based brokerage unit, according to a Bloomberg report. While the unit is floor based, all market making integrates with the electronic markets — an increasingly controversial topic.

When Goldman Sachs Group inc (NYSE:GS) COO Gary Cohen wrote what was considered a radical opinion piece in the Wall Street Journal, as reported in ValueWalk, this was interpreted as presenting ideas into the public domain that were damaging to the electronic market making and exchange business models, potentially a sign of things to come.

Goldman Sachs: Real risk, real reward considered

For Goldman Sachs Group inc (NYSE:GS), considered by some the most influential investment bank in the world, to exit market making comes at an interesting time.  The business has undergone significant consolidation, with the remaining market makers playing a high stakes game speed arms race with significant technology costs.  As an example, Virtu, which recently canceled their IPO amidst the furor over HFT, generates an annual profit of $250 million, which seems like a considerable amount.  However, they are managing notional value risk on over $60 trillion, a staggering amount if an outlier event were to catch a market maker on the wrong side of a flash crash – an increasingly realistic possibility.

“Smart money” chose to pass on business with significant risks

With the cost of entry to play the high speed game so high and the relative risk adjusted reward so low, Goldman Sachs Group inc (NYSE:GS), considered the “smart money,” and chose to pass.

There are significant additional risks in market making from a number of perspectives.

First, the regulatory risk that changes will come into play is said to be high.  Goldman Sachs Group inc (NYSE:GS), with perhaps the most extensive tentacles into Washington DC happenings as any financial firm in history, might have knowledge that the hammer is about to come down on HFT’s business model.

Second, there is potential criminal risk to certain forms of HFT.  Does Goldman Sachs even want to come close to touching a business that could actually get charged with criminal behavior when the reward is so relatively low?  While packaging opaque sub-prime mortgages was considered illegal in some quarters, it was enormously profitable.  To date the major banks have only paid fines for their behavior – a cost of business – and only a mid level Goldman Sachs Group inc (NYSE:GS) executive has been held civilly responsible in the issue.

Third, when the next crash happens the likelihood is that HFT is going to be blamed – and another flash crash could occur.  Contrary to Wall Street’s happy talk, arguments can be made that certain market structures are actually weaker than they were on May 6, 2010.

With all the risk and relatively little reward, who can blame Goldman Sachs Group inc (NYSE:GS)?

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