The End of Proprietary Trading: Collateral Damage

NEW YORK (TheStreet) -- Citigroup's(C ) sale of its Phibro energy trading unit to Occidental Petroleum(OXY ) may ultimately prove to be of little significance, but there is also a distinct possibility that the transaction signals a dramatic shift in how much risk banks are allowed to take.

Richard Bove, analyst with Rochdale Securities, is in the second camp, arguing that regulators and members of Congress are determined to castrate large banks. Among the changes he sees coming is one that would prohibit banks from using their own capital to make directional bets on the market -- a practice known as proprietary trading.

Banks often like to say they do very little proprietary trading, and it can be hard to draw bright lines between proprietary trading and so-called market making, which refers to the matching of buyers and sellers. Still, it is probably safe to say that proprietary trading has regularly caused swings of more than a billion dollars in quarterly profit or loss at many of the world's largest banks, including Morgan Stanley(MS ), JPMorgan Chase(JPM ), Bank of America(BAC ), Barclays, UBS, Credit Suisse and Deutsche Bank(DB ). Probably no institution is more associated with proprietary trading, however, than Goldman Sachs(GS ).

Bove says he's spoken with a number of investors that have been visited by former Federal Reserve Bank of New York President Gerald Corrigan, now a Goldman Sachs executive, who they say is extremely concerned about a severe regulatory clampdown on proprietary trading that would go to the heart of Goldman's business.

"He's been on the road speaking to large investment funds, particularly those that own Goldman Sachs' stock, and this is the issue," Bove told TheStreet. "The issue quite simply is that 'we are at risk of not being able to facilitate your trades because the government is not going to allow us to put capital on the desk, because it doesn't fit with their new view of how capital should be used in a banking company.'"