What good is Wall Street?

notes and quotes from Cassidy, John. “What Good is Wall Street?The New Yorker. 29 November 2010.

Big banks have transformed themselves from businesses whose profits were tied to the needs of their clients to huge trading houses whose focus is exploiting daily movements in markets.

Constant need to invent new financial products to sell — this financial innovation can be very dangerous (hello, synthetic CDOs).

Lord Adair Turner, Chairman of Britain’s Financial Services Authority: the products of Wall Street are “socially useless activity.”

At the peak of the boom, the financial firms’ profits comprised one third of all profits made by businesses in the United States. Wages were 60% higher in the financial sector than anywhere else.

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

Paul Woolley — Woolley Centre for the Study of Capital Market Dysfunction.

Woolley ran an investment firm for decades, realized that “financial institutions that react to market incentives in a competitive setting often end up making a mess of things.”

Once firms realized that markets were not efficient, they began to play their inefficiencies as a profit-making strategy. “A perfect storm of wealth destruction”

In a private partnership (pre-big-bank Wall Street), the people who own the firm take its losses, so this discourages extreme risk-taking. But big public firms have to take on enormous amounts of risk to pull off the profits that their shareholders expect.

Trading that serves a useful economic function:

  • market-making: “banks acquire large inventories of securities in order to facilitate buying and selling on the part of their clients.”
  • active trading to meet “their client’s wishes to either lay off risk or take it on.”

Banks also do/did a lot of trades that are not in service of traditional clients.

  • proprietary trading — bet own capital on movements in markets. Volcker rule intends to curb banks from taking risks with their depositors’ money, so proprietary trading is currently in a roll-back kind of phase
  • other speculative activities — (not eliminated by Dodd-Frank) — facilitating speculation by other banks, especially hedge funds
  • these create little or no economic value

Big-boy concept – “we’re all adults here,” you can expect others to do their due diligence, have no responsibility to explain risks to them (can sell them securities that your bank is short on, etc.)

Big banks say they need to be big in order to do the business their clients want/need as global corporations.

Most banks think trading is too lucrative to just stop doing, so they’re fighting Dodd-Frank.

Liquidity is the justification for market-making and other types of trading. Banks provide liquidity to markets, which is usually a good thing, except when it is misleading, and ends up causing big big problems (everybody wants to sell at once, markets sieze up)

Big Wall Street firms returned quickly to profitability and huge compensations.

Clawback – Wall Street’s response to criticisms of executive compensation. A bank gives its most highly paid employees some sort of deferred compensation, designed to decline in value if “profits” turn into losses. (restricted stock)

If financial industry creates any value at all, is it worth the compensation it’s been receiving?

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  1. […] Cate McCrea summarizes the article for Trade Practices, found here […]



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