Banks are backed into a corner, and the boom years aren't going to come back soon. A recent article in the Times, entitled “Is This the End of Wall Street As They Knew It?” makes the claim that "Banks have always had occasional bad years, but the sense on Wall Street is that this bad year is different."
Everybody's noticing because CEO bonuses are being slashed, and hedge funds are closing.
“There’s no other industry where you could get paid so much for doing so little,” a former Lehman trader said. Paul Volcker, whose eponymous rule is at the core of the changes, echoes an idea that more bankers than you’d think would agree with. “Finance became a self-justification,” he told me recently. “They made a lot of money trading with each other with doubtful public benefit.”
Since money is debt, the creation of debt is the creation of money. Once you grasp this, it is fairly easy to see How Money is Created From Nothing by Wall Street.
Because nobody makes money if money is not changing hands, instability is the very heartbeat of the financial industry: if there is no dip and soar, nobody can earn big money. This is why, for decades, Wall Street has actively cultivated bubbles and busts:
“In the quaint old days, Wall Street tended to earn its profits rather boringly by loaning money, advising mergers, and supervising bond issues and IPOs. The leveraging of the American economy—and the supercharging of the financial industry—began in earnest in the early eighties. And banks have profited from a successive series of financial bubbles, each bigger and more violent than the one preceding it. “Wall Street did a really good job convincing people it was really complicated and they were the only ones who could do it and it justified paying them millions of dollars,” a former Lehman trader explained. Credit was the engine that powered the explosion in bank profits. 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. The alphabet soup of complex vehicles that defined the 2008 crash—CLO, CDO, CDS—had all been developed to sell more credit.”
So, for decades now, banks have been creating bubbles of assets (i.e. creating debt) and riding it out when they crash, finding new ways to sell the debt (i.e. assets), and thereby creating enormous wealth for themselves through "leveraging," that is, through borrowing money against debt-assets that they own. Debt grew much faster than the actual economy, and as long as it did, people were making money.
But now, three years after this crash, Wall Street is noticing that things are not returning to normal: amazingly, the bubble-and-crash rhythm of the last three decades is just now starting to look to Wall Street as though it was unstable… in a bad way.
"Since the crash, and especially since the occupation of Zuccotti Park last September (which does appear to have rattled a lot of nerves), there has been a growing recognition on Wall Street that the system that had provided those million-dollar bonuses was built on a highly unstable foundation."
The real source of the change, the article says, is the much-maligned Dodd-Frank Financial Reform bill. This bill, the article claims, is spelling the end of this money-making spree by the financial industry:
"To comply with the looming regulations, banks have begun stripping themselves of the pistons that powered their profits: leverage and proprietary trading."
The crash brought banks to the teat of the government, where they could get loans with very low rates so that they could pay off their debtors and invest heavily: borrow $1 million at low interest, earn a great rate of return in a recovering market, give the money back and keep the extra for yourself.
"In the wake of the crash, Morgan Stanley and Goldman Sachs converted to bank holding companies to tap the “discount window,” the Fed’s pipeline of cheap funds that gave the banks an emergency source of liquidity. That move seemed smart then, but the stricter standards required of banks have now left them boxed in."
In addition, the passage of a version of the Volcker Rule into law is doing some good work. The Volcker Rule is the principle that banks cannot use deposits insured by the American taxpayer to make speculative investments. The idea that you can use mortgages underwritten by the government to bet on whatever financial dream you wish—removing all risk to you—was a license to print money and gamble indiscriminately with taxpayer money:
“After the big investment banks went public…Bank earnings and ever-rising asset values allowed them to borrow ever-larger amounts of money, which in turn juiced ever-greater profits. Banks, which had previously made their money advising corporations and underwriting securities, essentially became giant hedge funds (in 2007, Morgan Stanley held $1.05 trillion in assets supported by just $30 billion in equity). The triumph of the Wall Street system was the exploitation of the real-estate boom: Real estate enabled the biggest credit bubble ever conceived—and a bust of similar magnitude, which some shrewd traders also took advantage of.”
Thus, following this Rule, legislation now separates the hedge fund and investment banking arms of an organization from the divisions that lend to ordinary people. This prevents banks from using government-backed assets (i.e. debt) for speculative investments. It also has the side-effect that when banks’ customer or investment divisions fail, the other one won’t immediately come down with it.
The Rule also limits the liabilities that banks can hold, and bans conflict-of-interest trading, that is, it forbids a bank from selling ‘asset packages’ (i.e. other people’s debts) and then betting that they will fail (‘shorting’).
“In December 2011, the Fed announced it would compel banks over the next few years to effectively double the amount of capital they hold on their books, a move that would curb leverage and, ultimately, profits. At the boom’s peak, banks like Lehman and Bear Stearns levered up 30, even 40, to 1. Under the new rules, banks would only be able to borrow $12 for every dollar they spend.”
As a former Lehman trader says, “You can’t print the cheap money anymore.”
The most concise and helpful way to put it is that,
"We’ve made a decision as a nation to shrink the growth of the financial system under the theory that it won’t impact the growth of the nation’s economy."
That's a good theory. If we've really already made that decision, whoever made it deserves applause.
My only other reservation is considerable: in the closing paragraphs of the article, the author notes that Wall Street is good at finding loopholes and evading regulation, and CEOs are likely to receive their bonuses, only later. Both are true. In a word: the conclusion of the article seems too good to be true, so it probably is.
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Rob St. Amant
MJDN
Shannon Kelley
baltimore aureole
vzn
Barbara Joanne
Salon.com
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Here are two revealing Daily Show videos you might like: Jon Stewart argues that people should have the same rights as corporations: http://www.thedailyshow.com/watch/tue-march-16-2010/in-dodd-we-trust
Dodd-Frank bill: http://www.thedailyshow.com/watch/thu-july-28-2011/dodd-frank-update