Thursday, June 2, 2011

Wall Street's Image Problem

What are these guys actually doing?

I was up at Yale a few weeks ago talking to some undergraduates, and they were taking pot shots at the financial industry. The gist of it was that Wall Street was filled with a bunch of greedy paper pushers who add no value to society. They looked down on their classmates who hoped to enter Wall Street training programs.

On the first charge - greed - there may be some merit. After all, a typical investment banking job has brutal hours (100 weeks not uncommon), requires a high level of education, has a high wash-out rate, and, when you get right down to it, isn't that much fun. I sure as hell would want to be well paid to do something like that. In point of fact, I DID do something like that right out of college. You had no life. You were a slave.

On the second point - value to society - my undergrad friends are dead wrong, and this is where Wall Street has a serious image problem.

Quick - what does Wall Street make? Nothing, right? Nothing you can touch, for sure. But it does do two things, and it does them very well, at least most of the time. These things are both vitally important. Can you think what they are? If you can't, don't worry, you're not alone. The undergrads had no clue, and here's the thing: most people on Wall Street don't really know, either. They understand the job in front of them, but not the bigger picture, the good they are doing, intended or not.

One of my colleagues suggests they don't have to understand for Smith's invisible hand to work. Indeed, this might be true in a truly free market economy, but that's not what we live in anymore. If an industry can't justify itself to the broader public - if the value isn't made clear - that industry will find itself at the top of every regulator's and politician's hit list. This, in turn, raises costs and decreases the net value of the industry to society. I'm sure you can see a vicious cycle in this.

Still working out the answers? The first is - or should be - pretty easy. Wall Street allocates capital, moving it where it sits, unproductively, stuffed into proverbial mattresses, to where it is most needed, thus fueling economic growth by funding growing companies to produce things people want. Capital flow is savings turned into investments -- the grease in the wheels of our enormous economy and creates jobs. Without it, things grind to a halt.

Bankers and lawyers structure the offerings, syndicate desks determine pricing and allocate the risk across diverse intermediary firms, and salespeople place the securities with investors around the world. That, in a nutshell, is half of Wall Street.

The second is a bit trickier: Wall Street provides liquidity. Put simply, if you buy something you have a reasonable expectation that you can later sell it. This expectation makes one willing to pay a far higher price, thus enabling companies to raise far more capital, and more importantly lowering the cost of capital. This is no small deal. The first part - capital allocation - doesn't work without the second.

All those traders - maligned by the Yale crowd as being mere paper pushers and screen gazers - they are the ones making liquidity possible (along with their banks' balance sheets, of course). The thing is, if you asked a typical trader what beneficial role they were playing in the larger economy, he or she would likely stammer over the answer. And if he doesn't know the answer, how can someone outside the industry reasonably be expected to know the answer?

This is a problem, because like any industry, Wall Street, from time to time, runs into problems of its own creation. It did not, contrary to popular belief, create the debacle of 2008 or the current recession, but it certainly played a role. In times like these the problem becomes no one comes to your defense because they don't see anything on the positive side of the ledger.

The inherent invisibility of the product will always be a problem, because it's harder to understand what you can't see. The oil industry, a frequent Washington target, is at least understandable. Oil makes my car go and heats my home. Without it, I am stuck at home in the cold. liquidity? What's that?

In part, I blame our schools like Yale, because they're not teaching anything relevant anymore. But I also blame Wall Street. Its training programs never say what I just said in a few paragraphs. I went through the Salomon Brothers program back in the 80s, which was thought to be the top training program at the time, and none of this was covered. I could price a bond blindfolded at 30 paces, mind you, but talk about my role in the economy? Cue the stammering.

So, all you Wall Street senior executives reading this, perhaps you might set aside a mere few hours one day and explain to your trainees that they are not just little money-making machines, but they're doing the world some good. They may not care, but it's a start.


  1. Spoken like a true Wall Streeter. Wall Street serves a useful purpose when it is helping corporations and municipalities issue bonds and assisting in initial public offering.

    For most of Wall Street's business these days, they are guilty as charged. Our economy has become entirely too dependent on Wall Street speculation and now we have to bail them out every time they screw up. Wall Street has become a parasite draining the U.S. dry.

  2. I used to agree completely, Scott. I also think many players on Wall Street still work primarily in those roles.

    But at the top of the pyramid, I think things have changed quite a bit since you and I passed through Salomon's training class a long time ago.

    Although they still help allocate capital on Main Street, and they still provide liquidity to markets, for the last 30 or so years the largest investment banks have been busy creating new "products" that supposedly help Main Street to allocate capital and manage risk.

    In my opinion, these products are sold, not bought, because Main Street doesn't need hundreds of arcane new derivatives and other “structured” products to help them manage their risks. (How did that work out for Orange County? AIG?)

    But each product creates a new revenue stream for the giants, who make hefty fees when they "structure" and sell them, and then provide regular vig because the big boys are the only players who can really trade them.

    In a free market, doesn’t Goldman have a right to do this? Well, during the downturn, Goldman reported an entire quarter when they never had a down day trading. Is that a free market?

    Many in America now see Wall Street as a giant casino where the house, represented by the most visible firms such as Goldman, runs a rigged game where they cannot lose. Wall Street insiders, Ivy League economists, and government regulators trading jobs as they shuffle through a revolving door sure give some credence to this belief.

    Lehman and Bear Stearns may argue this point, but to the public, it sure looks like the taxpayer bailed out the TBTF banks on Wall Street--while the banks continued to mint money for themselves. Heads I win; tails you lose.

    Why Government Sachs was favored over Lehman is beyond the scope of your post or my comment, but I don't believe the public is quite so naive in thinking that Wall Street is no longer a benign allocator of capital.

    Don't get me wrong. Those Yale students have probably been brainwashed to think that capitalism is evil. They have no understanding of the important role free market capitalism has played in making our nation great and keeping it free. Traditionally, Wall Street was an important component of free market capitalism—for the reasons that you specified. But the crony capitalism practiced at the top of Wall Street--abetted by the government and exemplified by the TBTF policies-- give the "progressives" ammunition that they can use against free market capitalism.

    So, while I think it is important to defend Wall Street’s traditional role, I think those of us who believe in free market capitalism must be careful not to reflexively defend “Wall Street.”

  3. A lot of the new products of the financial industry, structured or otherwise, are not in themselves the problem.
    When they are used to obscure risk rather than properly value or hedge it, say, to securitize mortgages produced by government schemes to provide credit to unqualified borrowers, then deliberately miss-price those bonds at the behest of said government schemers and dump on investors, there is bound to be trouble. Trouble more of the governments making via coercive miss-allocation of capital and then co-opting the financial industry to cover up and defraud. No wonder they demanded and got bail outs.