Can Goldman Survive a Libya Scandal?

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Today’s story in the Wall Street Journal about Goldman Sachs’ shifty dealings with Libya’s sovereign-wealth fund is yet another blow to Goldman’s once-rock solid rap. That begs the question: how much more negative publicity can Goldman’s business take?

As Stephen Gandel argued on this blog a few weeks back, they can handle a lot. Sure, the firm’s stock price is down more than 16% this year, but at $140 per share, investors still think the company is worth more than $70 billion. And some Wall Street onlookers think the damage to Goldman’s stock price is already overdone. J.P. Morgan went so far as to upgrade its Goldman Sachs rating today from “neutral” to “overweight” with a target price of $175. The reason? “We see material re-leveraging potential. Hence, we upgrade Goldman Sachs,” J.P. Morgan said.

But re-leveraging isn’t going to be that easy for Goldman or any of Wall Street’s big banks. As Gandel notes, financial regulation under Dodd-Frank raises capital requirement and limits proprietary trading to curb banks’ risky bet-taking that translated into mega-profits pre- and post-financial crisis.

That said, don’t expect Goldman’s shady dealings to come to a sudden halt. The high-risk investing banks used to rely on to fluff up profit margins is merely moving down the street to hedge funds, the Wall Street profit-shops Dodd-Frank overlooked. Banks like Morgan Stanley and Goldman have already started closing doors and spinning off the trading operations that bet their own money, converting them into stand-alone hedge funds.

The spin-offs are good and bad for the economy. Piling those risky trades into hedge funds means run-of-the-mill bank depositors won’t suffer the losses of more egregiously bad bets. But concentrating riskier bets into opaque, unregulated hedge funds also means the government will be even more clueless in trying to prevent the next big market tumble.