Think Friday Was Just A Hiccup? Think Again

ByStander

Bank risk is back on the table. By suing none other than Goldman Sachs for fraud, the Securities and Exchange Commission has laid down a challenge to firms with large, often opaque trading operations.

As in all legal actions, the outcome is unpredictable. Goldman has said it will mount a vigorous defense. And even if it loses the case, financial penalties would likely be manageable.

But that doesn't mean the firm's nearly 13% share-price slump on Friday is a total overreaction. The case could hit profit at Goldman, and other banks, by hurting its reputation and leading to a push for more transparency and regulation.
[Goldmanherd]

On one level, the SEC's allegations are a reminder of the risk of investing in the "black boxes" some banks have become. That could fuel a push for more transparency on exactly what trading activities are taking place.

The SEC's claims also highlight the change in business model that arguably got Goldman into this spot. Over many years, it has seemingly shifted from a strictly client-focused firm toward a trading house where the line between clients and counterparties is blurred.

The SEC alleges Goldman withheld information from buyers of a CDO. In doing so, Goldman allegedly favored another customer, hedge fund Paulson & Co., which helped choose the securities in the CDOs and then bet against them. Investors in the CDO lost $1 billion; Goldman is said to have picked up $15 million in fees, although the firm says it ultimately lost $90 million.

Anything that made Goldman scale back usually profitable activity like this could take a bite out of earnings. That is where politics comes in. Given the push in Washington to pass a new financial-regulation bill, the SEC suit comes at a perfect time to help mute opposition.

If it results in stricter-than-otherwise legislation surrounding derivatives and trading activities, as proposed by former Federal Reserve Chairman Paul Volcker and the Obama administration, profits would suffer not just at Goldman.

First-quarter results from J.P. Morgan Chase showed, for example, that about 75% of the bank's net profit came from investment banking, which includes trading. Bank of America on Friday told a similar tale.

The SEC's Goldman case may also be just the first in a flood of actions against banks that sold exotic financial instruments based on mortgages. The growing threat of general litigation risk has already emerged in bank results. Bank of America said Friday it had taken a $500 million charge in both the first and fourth quarters related to litigation.

Such litigation, while potentially costly, should be manageable. After all, even big tobacco has fended off serious damage over the decades. The bigger risk for Wall Street is how much the latest assault damages individual firms' reputations and upends some of their most profitable activities.

永恒罗马

源济

aihutong

AGA7d

No surprise here, several big banks rely on trading for quite a while now. The question is - can it last long? Who the hell are losing the money to them? My guess is - pension funds, mutual funds etc. Not a pretty picture anyway - states have to raise tax in the future to make whole of the loss.

The core biz of the banks stinks. Without the trading and the free gifts from Ben, they probably will be in red.