Good News From Goldman Sachs

| Fri Jan. 21, 2011 6:00 AM EST

Here's some good news from the Wall Street Journal:

Goldman Sachs Group Inc.'s profit slide of 52% in the fourth quarter showed the securities giant's size and swagger aren't enough for it to escape the tightening squeeze of a regulatory overhaul and jittery clients and investors.

....Hedge funds are weaning themselves from some of the leverage used to make big bets, and U.S. companies are holding more than $2 trillion in stagnant cash. As a result, demand for the vast inventory of stocks, bonds and other investments that Goldman buys and sells on behalf of customers, generating commissions and other fees for the firm, fell in the latest quarter. Trading-related revenue shrank 31% to $3.64 billion from $5.25 billion in 2009's fourth quarter.

....Goldman faces a much longer-lasting threat from regulations spawned by last summer's Dodd-Frank law. While many of the new rules haven't been issued, Goldman already has pruned its proprietary-trading operations and other businesses likely to be reined in by regulators.

It's not snark to call this good news. It is premature, however. What would really be good news is if Dodd-Frank were responsible for Goldman's lower earnings, since the best way of knowing whether Dodd-Frank is working is to look at Wall Street profits. A safer Wall Street, almost by definition, is a less profitable Wall Street, so lower profits are the first sign that financial reform is working.

But we can't say that yet. "Jittery clients" might turn non-jittery as soon as the economy starts to recover, after all, and hedge funds, which aren't heavily affected by Dodd-Frank, might start ramping up their leverage again. Still, it's at least slightly heartening that maybe — just maybe — the changes Goldman has made in anticipation of Dodd-Frank will be relatively permanent. If that turns out to be the case, and Goldman does less prop trading, fewer highly-leveraged derivatives deals, and maintains higher capital ratios, then Dodd-Frank will be at least a minor success. If Goldman and other banks quickly figure out ways to evade the new rules and go back to business as usual, it will be a failure. In the end, profits will be the metric that tells the story.