The Goldman fiasco does not inspire confidence.  Tuesday April, 27, was not a good day for Goldman, for proprietary trading, for the OTC derivatives marketplace or for private-sector risk intermediation.  It definitely marked an inflection point for efforts to impose greater regulatory restraint upon the financial sector.  The old ways may have persevered through the LTCM, Enron, GSE and mortgage fiascos.  But today’s intense scrutiny of Goldman Sachs will alter the manner in which Wall Street goes about its business.  The near-term ramifications for our government-dominated Credit system and economy are anything but clear.  These days financial conditions are loose, confidence is high, market liquidity remains overabundant, and there is little difficulty intermediating risky Credit.  There is, at the same time, Bubble fragility unrecognized in an over-liquefied and overconfident marketplace. 

Reigning in Wall Street proprietary trading desks and derivatives operations pose major additional challenges for an already challenged private-sector Credit mechanism.  The Street’s new realities will make it more difficult for private-sector Credit to anytime soon supplant Washington’s Credit juggernaut.  From my perspective, this equates to massive deficits – for bigger and longer.  This means, at some point, greater market risk to a change in market perceptions and a surprising jump in yields.  And I would argue that Goldman and Wall Street’s problems ensure that the markets for risk intermediation – interest-rate, Credit, equities, currency, etc. – become less liquid and more vulnerable to dislocation.  

Perhaps it doesn’t matter all that much for now, but the dislocation that unfolded in European Credit default swap markets on Tuesday April, 27, 2010 portend serious issues for sovereign debt markets both abroad and at home.  There’s hope that European policymakers and the IMF can come up this weekend with a credible plan for Greek aid.  I would tend to believe that the “genie is out the bottle” and that global markets are in the early stage of adjusting to new uncertainties and risk realities.  Many that have planned on using derivatives markets to hedge future market risks may begin to reevaluate their approach to risk taking and management. 

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.