There is little good to say about Wall Street. I consider the entire industry to be essentially a blood sucking leech on the economic well being of the country. But we need some kind of capital formation
mechanism. Perhaps a strongly regulated market is worth having, but one that has been downsized and limited much more extensivly than what the new Finance Reform laws have in mind. Here are a few voices of concern as to the direction and intent of our capitalist financial mechanisms.
From Buddhist Quotes
“Greed, I say, is a great flood; it is a whirlpool sucking one down, a constant yearning, seeking a hold, continually in movement; difficult to cross is the morass of sensual desire. A sage does not deviate from truth, a brahmana stands on firm ground; renouncing all, he is truly called ‘calmed.’”
- Sutta Nipata
This is from the New Yorker
“What Good Is Wall Street?
Much of what investment bankers do is socially worthless.
by John Cassidy
November 29, 2010
For years, the most profitable industry in America has been one that doesn’t design, build, or sell a single tangible thing.
A few months ago, I came across an announcement that Citigroup, the parent company of Citibank, was to be honored, along with its chief executive, Vikram Pandit, for “Advancing the Field of Asset Building in America.” This seemed akin to, say, saluting BP for services to the environment or praising Facebook for its commitment to privacy. During the past decade, Citi has become synonymous with financial misjudgment, reckless lending, and gargantuan losses: what might be termed asset denuding rather than asset building. In late 2008, the sprawling firm might well have collapsed but for a government bailout. Even today the U.S. taxpayer is Citigroup’s largest shareholder.
Since the promulgation of Hammurabi’s Code, in ancient Babylon, no advanced society has survived without banks and bankers. Banks enable people to borrow money, and, today, by operating electronic-transfer systems, they allow commerce to take place without notes and coins changing hands. They also play a critical role in channelling savings into productive investments. When a depositor places money in a savings account or a C.D., the bank lends it out to corporations, small businesses, and families. These days, Bank of America, Citi, JPMorgan Chase, and others also help corporations and municipalities raise money by issuing stocks, bonds, and other securities on their behalf. The business of issuing securities used to be the exclusive preserve of Wall Street firms, such as Morgan Stanley and Goldman Sachs, but during the past twenty years many of the dividing lines between ordinary banks and investment banks have vanished.
When the banking system behaves the way it is supposed to… it is akin to a power utility, distributing money (power) to where it is needed and keeping an account of how it is used. Just like power utilities, the big banks have a commanding position in the market, which they can use for the benefit of their customers and the economy at large. But when banks seek to exploit their position and make a quick killing, they can cause enormous damage. It’s not clear now whether the bankers have really given up their reckless practices,… or whether they are merely lying low. In the past few years, all the surviving big banks have raised more capital and become profitable again. However, the U.S. government was indirectly responsible for much of this turnaround. And in the country at large, where many businesses rely on the banks to fund their day-to-day operations, the power still isn’t flowing properly. Over-all bank lending to firms and households remains below the level it reached in 2008.
The other important role of the banking industry, historically, has been to finance the growth of vital industries, including railroads, pharmaceuticals, automobiles, and entertainment. “Go back and pick any period in time,” John Mack, the chairman of Morgan Stanley, said to me recently. “Let’s go back to the tech boom. I guess it got on its feet in the late eighties, with Apple Computer and Microsoft, and really started to blossom in the nineteen-nineties, with Cisco, Netscape, Amazon.com, and others. These are companies that created a lot of jobs, a lot of intellectual capital, and Wall Street helped finance that. The first investors were angel investors, then venture capitalists, and to really grow and build they needed Wall Street.”
Yet Wall Street’s role in financing new businesses is a small portion of what it does. The market for initial public offerings (I.P.O.s) of stock by U.S. companies never fully recovered from the tech bust. During the third quarter of 2010, just thirty-three U.S. companies went public, and they raised a paltry five billion dollars. Most people on Wall Street aren’t finding the next Apple or promoting a green rival to Exxon. They are buying and selling securities that are tied to existing firms and capital projects, or to something less concrete, such as the price of a stock or the level of an exchange rate. During the past two decades, trading volumes have risen exponentially across many markets: stocks, bonds, currencies, commodities, and all manner of derivative securities. In the first nine months of this year, sales and trading accounted for thirty-six per cent of Morgan Stanley’s revenues and a much higher proportion of profits. Traditional investment banking—the business of raising money for companies and advising them on deals—contributed less than fifteen per cent of the firm’s revenue. Goldman Sachs is even more reliant on trading. Between July and September of this year, trading accounted for sixty-three per cent of its revenue, and corporate finance just thirteen per cent.
In effect, many of the big banks have turned themselves from businesses whose profits rose and fell with the capital-raising needs of their clients into immense trading houses whose fortunes depend on their ability to exploit day-to-day movements in the markets. Because trading has become so central to their business, the big banks are forever trying to invent new financial products that they can sell but that their competitors, at least for the moment, cannot. Some recent innovations, such as tradable pollution rights and catastrophe bonds, have provided a public benefit. But it’s easy to point to other innovations that serve little purpose or that blew up and caused a lot of collateral damage, such as auction-rate securities and collateralized debt obligations. Testifying earlier this year before the Financial Crisis Inquiry Commission, Ben Bernanke, the chairman of the Federal Reserve, said that financial innovation “isn’t always a good thing,” adding that some innovations amplify risk and others are used primarily “to take unfair advantage rather than create a more efficient market.”
Other regulators have gone further. Lord Adair Turner, the chairman of Britain’s top financial watchdog, the Financial Services Authority, has described much of what happens on Wall Street and in other financial centers as “socially useless activity”—a comment that suggests it could be eliminated without doing any damage to the economy. In a recent article titled “What Do Banks Do?,” which appeared in a collection of essays devoted to the future of finance, Turner pointed out that although certain financial activities were genuinely valuable, others generated revenues and profits without delivering anything of real worth—payments that economists refer to as rents. “It is possible for financial activity to extract rents from the real economy rather than to deliver economic value,” Turner wrote. “Financial innovation . . . may in some ways and under some circumstances foster economic value creation, but that needs to be illustrated at the level of specific effects: it cannot be asserted a priori.”
Turner’s viewpoint caused consternation in the City of London, the world’s largest financial market. A clear implication of his argument is that many people in the City and on Wall Street are the financial equivalent of slumlords or toll collectors in pin-striped suits. If they retired to their beach houses en masse, the rest of the economy would be fine, or perhaps even healthier.
Since 1980, according to the Bureau of Labor Statistics, the number of people employed in finance, broadly defined, has shot up from roughly five million to more than seven and a half million. During the same period, the profitability of the financial sector has increased greatly relative to other industries. Think of all the profits produced by businesses operating in the U.S. as a cake. Twenty-five years ago, the slice taken by financial firms was about a seventh of the whole. Last year, it was more than a quarter. (In 2006, at the peak of the boom, it was about a third.) In other words, during a period in which American companies have created iPhones, Home Depot, and Lipitor, the best place to work has been in an industry that doesn’t design, build, or sell a single tangible thing.
From the end of the Second World War until 1980 or thereabouts, people working in finance earned about the same, on average and taking account of their qualifications, as people in other industries. By 2006, wages in the financial sector were about sixty per cent higher than wages elsewhere. And in the richest segment of the financial industry—on Wall Street, that is—compensation has gone up even more dramatically. Last year, while many people were facing pay freezes or worse, the average pay of employees at Goldman Sachs, Morgan Stanley, and JPMorgan Chase’s investment bank jumped twenty-seven per cent, to more than three hundred and forty thousand dollars. This figure includes modestly paid workers at reception desks and in mail rooms, and it thus understates what senior bankers earn. At Goldman, it has been reported, nearly a thousand employees received bonuses of at least a million dollars in 2009.
Not surprisingly, Wall Street has become the preferred destination for the bright young people who used to want to start up their own companies, work for NASA, or join the Peace Corps. At Harvard this spring, about a third of the seniors with secure jobs were heading to work in finance. Ben Friedman, a professor of economics at Harvard, recently wrote an article lamenting “the direction of such a large fraction of our most-skilled, best-educated, and most highly motivated young citizens to the financial sector.”
Most people on Wall Street, not surprisingly, believe that they earn their keep, but at least one influential financier vehemently disagrees: Paul Woolley, a seventy-one-year-old Englishman who has set up an institute at the London School of Economics called the Woolley Centre for the Study of Capital Market Dysfunctionality. “Why on earth should finance be the biggest and most highly paid industry when it’s just a utility, like sewage or gas?” Woolley said to me when I met with him in London. “It is like a cancer that is growing to infinite size, until it takes over the entire body.”
At GMO, Woolley ran several funds that invested in stocks and bonds from many countries. He also helped to set up one of the first “quant” funds, which rely on mathematical algorithms to find profitable investments. From his perch in Angel Court, in the heart of the City, he watched the rapid expansion all around him. Established international players, such as Citi, Goldman, and UBS, were getting bigger; new entrants, especially hedge funds and buyout (private equity) firms, were proliferating. Woolley’s firm did well, too, but a basic economic question niggled at him: Was the financial industry doing what it was supposed to be doing? Was it allocating capital to its most productive uses?
At first, like most economists, he believed that trading drove market prices to levels justified by economic fundamentals. If an energy company struck oil, or an entertainment firm created a new movie franchise, investors would pour money into its stock, but the price would remain tethered to reality. The dotcom bubble of the late nineteen-nineties changed his opinion. GMO is a “value investor” that seeks out stocks on the basis of earnings and cash flows. When the Nasdaq took off, Woolley and his colleagues couldn’t justify buying high-priced Internet stocks, and their funds lagged behind rivals that shifted more of their money into tech. Between June, 1998, and March, 2000, Woolley recalled, the clients of GMO—pension funds and charitable endowments, mostly—withdrew forty per cent of their money. During the ensuing five years, the bubble burst, value stocks fared a lot better than tech stocks, and the clients who had left missed more than a sixty-per-cent gain relative to the market as a whole. After going through that experience, Woolley had an epiphany: financial institutions that react to market incentives in a competitive setting often end up making a mess of things. “I realized we were acting rationally and optimally,” he said. “The clients were acting rationally and optimally. And the outcome was a complete Horlicks.” Financial markets, far from being efficient, as most economists and policymakers at the time believed, were grossly inefficient. “And once you recognize that markets are inefficient a lot of things change.”
One is the role of financial intermediaries, such as banks. Rather than seeking the most productive outlet for the money that depositors and investors entrust to them, they may follow trends and surf bubbles. These activities shift capital into projects that have little or no long-term value, such as speculative real-estate developments in the swamps of Florida. Rather than acting in their customers’ best interests, financial institutions may peddle opaque investment products, like collateralized debt obligations. Privy to superior information, banks can charge hefty fees and drive up their own profits at the expense of clients who are induced to take on risks they don’t fully understand—a form of rent seeking. “Mispricing gives incorrect signals for resource allocation, and, at worst, causes stock market booms and busts,” Woolley wrote in a recent paper. “Rent capture causes the misallocation of labor and capital, transfers substantial wealth to bankers and financiers, and, at worst, induces systemic failure. Both impose social costs on their own, but in combination they create a perfect storm of wealth destruction.”
Many banks believe that trading is too lucrative a business to stop, and they are trying to persuade government officials to enforce the Dodd-Frank bill in the loosest possible way. Morgan Stanley and other big firms are also starting to rebuild their securitization business, which pools together auto loans, credit-card receivables, and other forms of credit, and then issues bonds backed by them. There have even been some securitizations of prime-mortgage loans. I asked John Mack if he could see subprime-mortgage bonds making a comeback. “I think in time they will,” he replied. “I hope they do. I say that because it gives tremendous liquidity to the markets.”
“Liquidity” refers to how easy or difficult it is to buy and sell. A share of stock in a company on the Nasdaq is a very liquid asset: using a discount brokerage such as Fidelity, you can sell it in seconds for less than ten dollars. A chocolate factory is an illiquid asset: disposing of it is time-consuming and costly. The classic justification for market-making and other types of trading is that they endow the market with liquidity, and throughout the financial industry I heard the same argument over and over. “You can’t not have banks, and you can’t not have trading,” an executive at a big private-equity firm said to me. “Part of the value in a stock is the knowledge that you can sell it this afternoon. Banks provide liquidity.”
But liquidity, or at least the perception of it, has a downside. The liquidity of Internet stocks persuaded investors to buy them in the belief they would be able to sell out in time. The liquidity of subprime-mortgage securities was at the heart of the credit crisis. Home lenders, thinking they would always be able to sell the loans they made to Wall Street firms for bundling together into mortgage bonds, extended credit to just about anybody. But liquidity is quick to disappear when you need it most. Everybody tries to sell at the same time, and the market seizes up. The problem with modern finance “isn’t just about excessive rents and a misallocation of capital,” Paul Woolley said. “It is also crashes and bad macroeconomic outcomes. The recent crisis cost about ten per cent of G.D.P. It made tackling climate change look cheap.”
In the upper reaches of Wall Street, talk of another financial crisis is dismissed as alarmism. Last fall, John Mack, to his credit, was one of the first Wall Street C.E.O.s to say publicly that his industry needed stricter regulation. Now that Morgan Stanley and Goldman Sachs, the last two remaining big independent Wall Street firms, have converted to bank holding companies, a legal switch that placed them under the regulatory authority of the Federal Reserve, Mack insists that proper supervision is in place. Fed regulators “have more expertise, and they challenge us,” Mack told me. Since the middle of 2007, Morgan Stanley has raised about twenty billion dollars in new capital and cut in half its leverage ratio—the total value of its assets divided by its capital. In addition, it now holds much more of its assets in forms that can be readily converted to cash. Other firms, including Goldman Sachs, have taken similar measures. “It’s a much safer system now,” Mack insisted. “There’s no question.”
That’s true. But the history of Wall Street is a series of booms and busts. After each blowup, the firms that survive temporarily shy away from risky ventures and cut back on leverage. Over time, the markets recover their losses, memories fade, spirits revive, and the action starts up again, until, eventually, it goes too far. The mere fact that Wall Street poses less of an immediate threat to the rest of us doesn’t mean it has permanently mended its ways.
Perhaps the most shocking thing about recent events was not how rapidly the big Wall Street firms got into trouble but how quickly they returned to profitability and lavished big rewards on themselves. Last year, Goldman Sachs paid more than sixteen billion dollars in compensation, and Morgan Stanley paid out more than fourteen billion dollars. Neither came up with any spectacular new investments or produced anything of tangible value, which leads to the question: When it comes to pay, is there something unique about the financial industry?
Thomas Philippon, an economist at N.Y.U.’s Stern School of Business, thinks there is. After studying the large pay differential between financial-sector employees and people in other industries with similar levels of education and experience, he and a colleague, Ariell Reshef of the University of Virginia, concluded that some of it could be explained by growing demand for financial services from technology companies and baby boomers. But Philippon and Reshef determined that up to half of the pay premium was due to something much simpler: people in the financial sector are overpaid. “In most industries, when people are paid too much their firms go bankrupt, and they are no longer paid too much,” he told me. “The exception is when people are paid too much and their firms don’t go broke. That is the finance industry.”
Given the code of silence that Wall Street firms impose on their employees, it is difficult to get mid-level bankers to speak openly about what they do. There is, however, a blog, The Epicurean Dealmaker, written by an anonymous investment banker who has for several years been providing caustic commentary on his profession. The biography on his site notes, “I facilitate, justify, and advise parties to M&A transactions, when I am not advising against them.” In March, 2008, when some analysts were suggesting that the demise of Bear Stearns would lead to a change of attitudes on Wall Street, TED—the shorthand appellation the author uses—wrote, “I, for one, think these bankers will be even more motivated to rape and pillage the financial system in order to rebuild their ill-gotten gains.” Seven months later, on the eve of the bank bailout, TED opined, “Let hundreds of banks fail. Let tens of thousands of financial workers lose their jobs and their personal wealth. . . . The financial sector has had a really, really good run for a lot of years. It is time to pay the piper, and I, for one, have little interest in using my taxpayer dollars to cushion the blow. After all, I am just another heartless Wall Street bastard myself.”
The Epicurean Dealmaker is right: Wall Street bankers create some economic value. But do they create enough of it to justify the rewards they reap? In the first nine months of 2010, the big six banks cleared more than thirty-five billion dollars in profits. “The cataclysmic events took place in the fall of 2008 and the early months of 2009,” Roger Altman, the chairman of Evercore, said to me. “In this industry, that’s a long time ago.”
Despite all the criticism that President Obama has received lately from Wall Street, the Administration has largely left the great money-making machine intact. A couple of years ago, firms such as Citigroup, JPMorgan Chase, and Goldman Sachs faced the danger that the government would break them up, drive them out of some of their most lucrative business lines—such as dealing in derivatives—or force them to maintain so much capital that their profits would be greatly diminished. “None of these things materialized,” Altman noted. “Reforms and changes came in, but they did not have a transformative effect.””
Read more http://www.newyorker.com/reporting/2010/11/29/101129fa_fact_cassidy?printable=true#ixzz16bJkRTxA
“Proprietary Trading Goes Under Cover
By Michael Lewis - Oct 27, 2010 1:48 PM PT
A few weeks ago we asked a simple question: Why are the same Wall Street banks that lobbied so hard to dilute the passages in the Dodd-Frank financial overhaul bill banning proprietary trading now jettisoning their proprietary trading groups, without so much as a whimper?
The law directs regulators to study the prop trading ban for another 15 months before deciding how to enforce it: why is Wall Street caving now?
The many answers offered by Wall Street insiders in response boil down to a simple sentence: The banks have no intention of ceasing their prop trading. They are merely disguising the activity, by giving it some other name.
A former employee of JPMorgan, for instance, wrote to say that the unit he recently worked for, called the Chief Investment Office, advertised itself largely as a hedging operation but was in fact making massive bets with JPMorgan’s capital. And it would of course continue to do so. JPMorgan didn’t respond to a request for comment.”
This From Gulf Times
“The crooked path of financial reform
By Jean Pisani-Ferry/Brussels
Latest Update: Sunday28/11/2010November, 2010, 12:08 AM Doha Time
Two years ago, governments saved the necks of the world’s financial markets. Yet today, those same markets intimidate governments, or at least some of them.
In Europe, the market for Greek debt has frozen, and interest-rate spreads between Irish and German euro-denominated debt recently reached alarming levels. Spain has succeeded in reducing its own spread vis-à-vis Germany but only after a policy U-turn.
Portugal has announced a major austerity package, hoping for the same effect. But, even when they are not in danger of losing access to the bond market, most governments in the developed world nowadays anxiously await the pronouncements of the same rating agencies that they were recently vilifying.
This change of fortune is shocking. To public opinion, it looks as if arrogant financial-market professionals learned nothing from the crisis, feeding the impression that nothing has changed – except for the worse.
Governments with a mandate to domesticate financial markets appear to have produced a lot of sound and fury, but little reform.
Whether deliberately or not, regulators seem to have missed their chance to implement serious changes to the rules of global finance, and governments are now so weakened that they are at the mercy of those who, not long ago, were begging them for help.
This politically devastating sentiment fuels resentment against markets and financiers. Nevertheless, while no one is proclaiming, “mission accomplished”, it is not true that nothing has been done to reform finance.”