Goldman Sachs, once renowned for placing winning bets, has taken a significant hit in its trading revenues. The firm has cut down its risk exposure to lowest since the third quarter of 2006. To those with a myopic perspective, it may seem to be a bad decision to take too little risk. However, we believe that risk averseness has helped the firm to contain the potential losses. Even with less capital at stake, the firm has ended up either making losses on bets or taking up expensive hedges that eroded the profits. Imagine the extent of damage had it subjected more capital to the same losing bets in the wake of rising Europe debt crisis and U.S fiscal deficit
The recent disclosure marks a significant turning point in firm's strategy in response to regulatory, political and economic uncertainties. And the trend seems to be making its way across other Wall Street offices as well. The focus is shifting away from trading operations to regulation and risk management. And firms are really justified in doing so. While it may be hard to resist the temptation of earning revenues based on speculative bets, this greed is no good. Such a trend will only lead to an asset bubble that will ultimately burst leading to another round of other bank failures. And considering the futility of previous round of bail outs, there may be none this time.
Seems like the firms such as Goldman Sachs have retained the lessons learnt from the previous financial crisis. The 'too big to fail' (TBTF)
logic might not come to rescue them this time should they goof up once again. The stability of nation can't be left to the mercy of reckless decisions of selected people at these firms where the ability of financial regulators to oversee their operations is limited. Any sort of government guarantee against failure can only lead to market distortions. It will only incentivize executives to take more risks to realize maximum short term gains and ignore the risks that tag along. Even if the government manages to control fiscal defict, a lack of control on speculative trades could lead to a bank failure and the resulting bail out will bring the situation back to square one.