The End of Wall Street As They Knew It

notes on Sherman, Gabriel. The End of Wall Street as they Knew It.” New York Magazine. 5 February 2012.

From the outside, the seven- and eight-figure payouts that star bankers earned could seem obscene, immoral even. But on the inside, the outlandish compensation reflected a strict, almost moral logic.

-Wall Street as meritocracy means that the bonuses are a ranking system for whoever is bringing in the most money, creating the most value.

-Post-2008, this kind of crazy year-end cash compensation is being capped, exchanged for stock bonuses, or severely cut.

-Wall Street is in bad shape not only because of the crash, the poor economy globally, but it has bigger structural issues.

The Dodd-Frank financial-­reform act, much maligned, has already begun to change the shape of the financial system—even before a number of its major provisions are proposed to go into full effect this coming July. To comply with the looming regulations, banks have begun stripping themselves of the pistons that powered their profits: leverage and proprietary trading.

The bill’s major provisions: forcing banks to reduce leverage, imposing a ban on proprietary trading, making derivatives markets more transparent, and ending abusive debit-card practices

-With new restrictions on the banks, the kind of money that was being made on Wall Street prior to 2008 may never be made back, and these kind of compensation cuts may be here to stay. Reducing risk is bad news for the banks’ profits.

“If you’re a smart Ph.D. from MIT, you’d never go to Wall Street now,” says a hedge-fund executive. “You’d go to Silicon Valley. There’s at least a prospect for a huge gain. You’d have the potential to be the next Mark Zuckerberg. It looks like he has a lot more fun.”

-With the sort of foundational shock that the crash brought, there comes a need for a reassessment of the basic values and functions of the financial industry — some self-examination, as it were.

[M]any acknowledge that the bubble­-bust-bubble seesaw of the past decades isn’t the natural order of capitalism—and that the compensation arrangements just may have been a bit out of whack.

– Right after the crash — due to the bailouts — the banks were still profitable. This gave rise to the idea that the crisis really didn’t change anything. Since the passage of Dodd-Frank, these profits have been sliding way down.

-Brief history: pre-1980s, Wall Street made money “loaning money, advising mergers, and supervising bond issues and IPOs.” Then in the 80s the leveraging began, and:

From junk bonds in the eighties to the emerging-markets crisis in the nineties to the subprime mania of the aughts, Wall Street developed new ways to produce, package, and sell debt to willing investors. “If you look at the past 25 years, the world economy was going through a process of leveraging,” a senior Citigroup executive said. “Debt has grown faster than economic growth.

– Once the investment banks were public, they were much more willing to take risk than they had been as private entities.

Banks, which had previously made their money advising corporations and underwriting securities, essentially became giant hedge funds.

– Real estate fueled the last, biggest, bubbles, and now that that market is so diminished, with no immediate sign of bouncing back, everything on Wall Street is slowed.

– The end of proprietary trading and high amounts of leverage for the big banks means the end of enormous profit, basically.

– And hedge funds are doing as poorly as the banks. There’s thousands of funds following the same trades, because the risk-averse market means that only the most obviously successful choice seems worth it.

“We used to rely on the public making dumb investing decisions,” one well-known Manhattan hedge-fund manager told me. “but with the advent of the public leaving the market, it’s just hedge funds trading against hedge funds. At the end of the day, it’s a zero-sum game.” Based on these numbers—too many funds with fewer dollars chasing too few trades—many have predicted a hedge-fund shakeout, and it seems to have started. Over 1,000 funds have closed in the past year and a half.

– The money from Wall Street went, in part, to large tax payments which went, in part, to New York City’s public — “New York made a bargain: It would tolerate the one percent’s excessive pay as long as the rising tax base funded the schools, subways, and parks for the 99 percent.”

– While Wall Street figures out a new way of doing business, de-leveraged and without prop trading, the New York economy will have to figure out some things as well.

– Many of these “fat cat” execs say they support tax increases as a solution.

– But will restrictions on American banks cause problems for them in the global market?

“Reversion to the mean is the rule of the financial market.”

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