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Wall Street Whispers: Goldman Playing Catch-Up

After financial regulatory reform, Goldman and other banks are starting to face a new reality.



) -- Don't let the hype fool you -- none of this is good for

Goldman Sachs

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After months of assurances from lawmakers that they'd crack down on Wall Street, and from banks that they'd get around that gnarly financial reform bill, it seems the tide has finally broken: Goldman Sachs is figuring out the least costly way to get rid of its proprietary trading operations. It's a key issue since Goldman's trading and principal investments division has delivered 78% of revenue so far this year.

But for anyone worried about Goldman's competitive edge, don't you worry.

Morgan Stanley

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Bank of America

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(C) - Get Free Report

are making similar moves, and probably -- though less vocally -- so is

JPMorgan Chase

(JPM) - Get Free Report


Once the so-called "Volcker rule" is put in place, it will be tough to get around. The measure will prevent banks from trading their own capital for profit. It will also prevent them from owning significant stakes in hedge fund and private-equity



The rule is tough and unexpected -- even if its


doesn't agree. The few "loophole lawyers" who sounded tough about skirting regulations when I spoke with them in the winter and spring had no concrete ideas about how to get around the Dodd-Frank bill when I spoke with them more recently.

Perhaps that is posturing. Perhaps they haven't figured it out yet. Perhaps they have, but don't want to reveal the strategies.

In any event, it's hard to imagine what Goldman and its peers could possibly do to skirt the new rules. First, because there are no more

off-balance sheet

vehicles in which to store

secret goods

. Second, because the Dodd-Frank bill cracks down not just on trading, but lending, general consumer finance and derivatives.

Sure, it's possible for banks to wiggle around this stuff the same way they have in the past. For instance, the SEC could have brought the same charges against Goldman Sachs in 2007 that it did in 2010; it just wasn't

paying attention

. In that regard, financial reform is more a matter of enforcement than anything else.

Such regulatory culpability is similar to most of the high-profile cases brought against banks over the past couple of years in

judicial courts

or the

court of public opinion

. But for the time being, it seems that the only way to "get around" financial reform will be to do so illegally or questionably legally. While Goldman won't disclose details of its plans quite yet, the firm wants to get out the message that it's doing everything above-board.

"As we've said all along, we are considering our options," says spokesman Michael DuVally. "When we have something to announce, we'll announce it. Of course, anything we do will comply with the law."

Investors who are interested in Goldman's future profits can take a cue from other big banks. Many have been getting ahead of reform measures, even if they won't be implemented for a few years.

Bank of America has gotten rid of a host of assets recently, selling equity stakes in

foreign banks

, selling limited private-equity partnerships and

spinning off

a private-equity division -- even exiting its holdings in


(MA) - Get Free Report

. In other words, lots of things that appear to be proprietary trading or PE-related were on the cutting board.

As for Morgan Stanley, the Street is buzzing about its potential sale of an in-house hedge-fund firm called FrontPoint Partners.

Citigroup sold its entire Citi Alternative Investments business to Skybridge Capital back in April.

Meanwhile, JPMorgan hasn't said much about how it's approaching finreg. But it's safe to say there will be similar changes at a bank that consistently ranks at the top of league tables.

So, what's all of this mean for Goldman, Morgan Stanley, Bank of America-Merrill, Citi, JPMorgan, et al? For the time being, they may end up finding fewer profits in trading -- as the second quarter made plain -- but will certainly find new areas for growth.

One important element of the financial reform bill is that it didn't prevent banks from

all types of trading

, just the proprietary kind. That means talented traders who stick around will be shifted into positions where they can leverage their expertise for customers. It may take a little time to adjust, but asset-management fees will increase accordingly, thereby redistributing profit to the bottom line. Banks may also build other fee-driven relationships with the firms to which they sell trading, hedge fund and private equity businesses.

Bank of America

outlined such a strategy

in March. Morgan Stanley and

Lazard (LAZ) - Get Free Report

started delivering on such a strategy during the second quarter. Goldman still seems to be figuring things out.

Goldman Sachs has been known as the smartest firm on Wall Street for some time. Last quarter it appeared to have

lost its bearings

a bit. It's hard to blame management for not wanting to give up a golden goose -- albeit a flighty one -- of prop-trading. But now, it's time to accept that it's time to adapt.

-- Written by Lauren Tara LaCapra in New York


Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.