Lost prestige
“Banking is the industry that failed. Banks are meant to allocate capital to businesses and consumers efficiently; instead, they ladled credit to anyone who wanted it. Banks are supposed to make money by skilfully managing the risk of transforming short-term debt into long-term loans; instead, they were undone by it. They are supposed to expedite the flow of credit through economies; instead, they ended up blocking it. The costs of this failure are massive. Frantic efforts by governments to save their financial systems and buoy their economies will do long-term damage to public finances. The IMF reckons that average government debt for the richer G20 countries will exceed 100% of GDP in 2014, up from 70% in 2000 and just 40% in 1980.”
The Nation? Nope. The Economist. Andrew Palmer of the Economist to be precise.
Now that the IMF estimates that the losses from the last credit boom will be close to $4 trillion — with two thirds of the losses coming from the world’s banks — it is rather hard to argue with him.
Yet only two years ago, the financial system of the US — and for that matter the UK — were the envy of much of the world.
Securitization was thought to have protected the core of the financial system from the risks associated with the rup-up in home prices (see paragraph 5 on p. 8 of the IMF’s 2007 assessment of the US) China, as Peter Goodman reminds us, wanted to import Anglo-Saxon financial know-how to help strengthen its banks.
Some things haven’t changed over the past couple of years, but an awful lot has.
bsetser: China, as Peter Goodman reminds us, wanted to import Anglo-Saxon financial know-how to help strengthen its banks.
And they wildly succeeded. It’s one of those “do what I say, and not what I do.” You had lots of Wall Street bankers going to China to give lectures on the importance of good risk management, which the Chinese banks acted on. Meanwhile, those same lectures were ignored on Wall Street.
It’s a matter of incentives. After looking at what happened to Suharto, the Chinese government figured out that bad risk management would threaten the continued rule of the Communist Party so there was high level support for implementing good risk management in Chinese banks. By contrast, there wasn’t any reason for US banks to implement good risk management.
One thing that you have to understand is with some notable exceptions before last year, risk management was a career dead end on Wall Street.
One weird consequence is that Chinese I think right now have a much more favorable impression of bankers and the banking industry than most Americans.
The most trivial definition of banking ,is the transformation of savings in investments.
This definition by itself carries the social responsability of the industry.
Twofish: One weird consequence is that Chinese I think right now have a much more favorable impression of bankers and the banking industry than most Americans.
DJC: Actually after the Lehman fiasco on Wall Street, the Chinese have a more favorable impression of state-owned Chinese banks and absolute fear of US Banks. Now Chinese companies feel their money is safer with state-owned Chinese banks. The savings of over twenty thousand Hong Kong retirees invested in AA+ Lehman mini-bonds were vaporized. I wouldn’t want to be a salesman selling AIG insurance products to the Chinese public. Incidentally, the US Consulate in Guangzhou China is located in an AIG Insurance building. Now that really is a loss of prestige.
lost prestige? in some cases, although deferred for some got larger bonuses last year than the prior year, and are expecting even bigger $$$ this year.
all this media talk of limiting and capping bonus pay is bogus, it’s just selling news to the masses. nothing is going to change.
Parties starting this weekend in the hamptons will be bigger than ever. For those to think that things are bad, swing by the Frick 2nite.
p.s. i do leave note that the music still played until the titantic sunk:)
Brazil and China eye plan to axe dollar
By Jonathan Wheatley in São Paulo
Published: May 18 2009 18:24 | Last updated: May 18 2009 20:54
Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil’s central bank and aides to Luiz Inácio Lula da Silva, Brazil’s president.
The move follows recent Chinese challenges to the status of the dollar as the world’s leading international currency.
FollowTheMoney: lost prestige? in some cases, although deferred for some got larger bonuses last year than the prior year, and are expecting even bigger $$$ this year.
The media points at the one or two idiots that got bigger bonuses this year than last, and ignores that practically everyone in finance got salary cuts and pink slips this year.
FollowTheMoney: all this media talk of limiting and capping bonus pay is bogus, it’s just selling news to the masses. nothing is going to change.
Depends. If the economy gets back to something approaching normal, then yes we will quickly go back to business as usual. If things fall apart, then you’ll have people raiding the street with pitchforks.
Personally, I think that incentive structure sort of makes some since.
Twofish-
The people i know got larger bonuses than ever last year, then again i can’t speak for everyone…
Things can’t be bad when you have 29 year olds looking at 8M dollar pads cash down…
I am not going to name firms or hedge funds, but yes i can tell you based on my relationships that bonuses increased in 2008 and will likely accelerate in 2009. It’s simply the media spinning all this bogus talk of limiting pay, limiting this and that. End of day W-street will find a way to make money, there’s plenty of loopholes for hedge funds and ibanks to structure profits.
Again as i’m mentioned before i’m a man of balance and moderation. I’m very happy that friends continue to collect massive 7-8 digit bonuses (late 20’s, early 30’s) and all i can is whatever they’re doing, keep doing it!
Matt Taibbi says it best:
FollowTheMoney: The people i know got larger bonuses than ever last year, then again i can’t speak for everyone…
We know different people then.
FollowTheMoney: Things can’t be bad when you have 29 year olds looking at 8M dollar pads cash down…
Actually things are pretty bad if that happens because if that happens then it means that people are still likely to be doing stupid things.
FollowTheMoney: I am not going to name firms or hedge funds, but yes i can tell you based on my relationships that bonuses increased in 2008 and will likely accelerate in 2009.
And I can tell you that at least in some large firms, bonuses fell by 50% off 2008, base pay was frozen, and you had 20% layoffs. Also, this is rather in line with the total Wall Street bonus pools.
Your friend must work for some hedge fund that got lucky late last year.
FollowTheMoney: End of day W-street will find a way to make money, there’s plenty of loopholes for hedge funds and ibanks to structure profits.
To structure profits you have to have profits.
FollowTheMoney: I’m very happy that friends continue to collect massive 7-8 digit bonuses (late 20’s, early 30’s) and all i can is whatever they’re doing, keep doing it!
I’m a bit older and hopefully wiser. Usually when people end up making massive amounts of money, it usually means that they are gambling and just hit the jackpot.
If you were in a hedge fund that shorted the market at just the right time last year, yes you might have made a killing, but don’t mistake luck for skill.
Twofish: And I can tell you that at least in some large firms, bonuses fell by 50% off 2008, base pay was frozen, and you had 20% layoffs. Also, this is rather in line with the total Wall Street bonus pools.
Not enough. If the bankers had any shame at all, bonuses in 2008 would have been exactly zero and all derivative traders would have been offered a retention package to wind down their portfolios and then fired.
But, of course we know by now Wall Streeters have no shame.
FollowTheMoney: all this media talk of limiting and capping bonus pay is bogus, it’s just selling news to the masses. nothing is going to change.
It’s not the general public that you have to worry about. Lot’s of people have been laid off and have had salary cuts in finance, if you start driving by in your new sports car and start spending large amount of money in front of ex-traders, they aren’t going to be too happy about that.
If you have a politician that really believes in decent wages for decent work, and manages to get people who are making $150K mad as hell at the people that are making $2M, then you might get something done, because the people making $150K know where the bodies are buried and who buried them.
observer: Not enough. If the bankers had any shame at all, bonuses in 2008 would have been exactly zero.
In which case everyone just raises the base salaries, and you end up spending more money.
This is precisely what worries me about all of the public anger is that the multi-millionaires that created the mess will find loopholes and keep their money, and the brunt of public anger will be directed at people that don’t have that much money.
If you zero 2008 bonuses, then the people that created the mess in 2006 and 2007 keep their money, while anyone newly hired to fix the mess gets nothing.
observer: All derivative traders would have been offered a retention package to wind down their portfolios and then fired.
There are competent derivative traders, and there are idiot derivative traders. One problem with being a competent derivative trader is that you get hired by a company that believes in paying people what they are worth, which means that you might end up with less money to begin with.
The trouble is that if you clamp down on all derivative traders, you end up rewarding idiot traders that worked for idiot firms that took the money and ran, and you end up punishing people that are competent.
People are angry. People should be angry, but right now, I’m just maintaining a low profile, hoping that the economy improves enough so that people can take a few deep breathes, and we can figure out how to rationally structure compensation.
The problem with lynch mobs is that the end up punishing the wrong people.
My brother, a recent NYU Stern graduate, notes that that the financial industry doesn’t actually create value.
My own personal observation is that the financial industry is there to server the economy, not the other way around.
Even the British acknowledge the inevitable…
British Foreign Secretary: China ready to join US as world power
http://www.guardian.co.uk/politics/2009/may/17/david-miliband-china-world-power
David Miliband today described China as the 21st century’s “indispensable power” with a decisive say on the future of the global economy, climate change and world trade.
The foreign secretary predicted that over the next few decades China would become one of the two “powers that count”, along with the US, and Europe could emerge as a third only if it learned to speak with one voice.
The remarks, in a Guardian interview, represented the most direct acknowledgement to date from a senior minister, or arguably from any western leader, of China’s ascendant position in the global pecking order.
Miliband said a pivotal moment in China’s rise came at the G20 summit last month in London. Hu Jintao, China’s president, arrived as the head of the only major power still enjoying strong growth (expected to be 8% this year), backed by substantial financial reserves.
“The G20 was a very significant coming of economic age in an international forum for China. If you looked around the 20 people sitting at the table … what was striking was that when China spoke everybody listened,” Miliband said.
Twofish: This is precisely what worries me about all of the public anger is that the multi-millionaires that created the mess will find loopholes and keep their money, and the brunt of public anger will be directed at people that don’t have that much money.
Oh please. Name one person or organization who is getting “unfairly” blamed right now.
The point is to be vigilant against anyone gaming the system via loopholes. It is total BS to say, “someone will always find a way to break the rules, so lets not have any rules”.
Twofish: There are competent derivative traders, and there are idiot derivative traders.
Yeah, 99% of derivative traders give the rest of them a bad name.
Since we can’t reliably identify the so-called competent ones, and since overall derivative traders do far more harm than good, we’d all be better off without these guys (except Wall St that is).
observer: Oh please. Name one person or organization who is getting “unfairly” blamed right now.
Me.
observer: The point is to be vigilant against anyone gaming the system via loopholes. It is total BS to say, “someone will always find a way to break the rules, so lets not have any rules”.
The point is to separate the innocent from the guilty. If you just want to punish the guilty, then it’s easy, shoot everyone. If you want to punish the guilty but spare the innocent or not so guilty, it gets harder.
And what I’m saying is that you are creating a system in which the innocent get punished more harshly than the guilty, which is probably not what you want.
observer: Yeah, 99% of derivative traders give the rest of them a bad name.
It’s probably about half and half. Also a lot depends on corporate culture. Put a decent person in a bad culture, and pretty soon he is going to end up behaving badly.
observer: Since we can’t reliably identify the so-called competent ones, and since overall derivative traders do far more harm than good, we’d all be better off without these guys (except Wall St that is).
Overall derivatives for all their problems end up making things like fixed interest, prepayable mortgages possible. No bank would be able to offer fixed interest mortgages with no prepayment penalty without mortgage backed securities and interest rate swaps. And then there is insurance, without things like cat bonds and interest rates swaps, the whole reinsurance industry would be impossible. CDO’s were wildly misused for mortgages, but they really are very useful for funding high-risk high-technology companies.
Then there are things like oil futures so that airlines can insure themselves against price spikes, and grain futures so that farmers aren’t wiped out by bad weather. Put and call options so that people can decide the level of risk they want in the stock market, etc. etc.
And that’s in the US. In most countries of the world, derivative securities function as substitutes for mutual funds. NYC is actually a small market for most derivatives. The big centers for derivatives are London and HK, because you don’t have anything quite like Fidelity or Vanguard in Europe and East Asia, and derivative securities play that role.
Larry: My brother, a recent NYU Stern graduate, notes that that the financial industry doesn’t actually create value.
I strongly disagree (and maybe it’s the people that I hang around). You have $X billion and lots of great ideas. Correctly deciding which ideas get funded and how much and doing it correctly creates value. Getting those decisions wrong destroys value.
You can see how important finance is by seeing the mess that happens when it gets done badly. If we had a system that spent less money on stupid real estate and more money on factories and municipal bonds to build schools, roads, and hospitals, that would have generated a huge amount of value.
If you look at every major social problem in the world, hunger, poverty, war, disease. Most of it comes down to issues of money and finance, and if you get money and finance *right*, then there is no end to the amount of good that you can do. Get it wrong, well just look around you…..
I would say the core failures are:
1. The GOP’s version of reality – which has a strong libertarian streak – in which self-regulation of both companies and markets works better than government regulation. You’d think that would be self-evident but people defend these failed ideas daily.
2. The GOP version of market capitalism. No one seriously attacks the concept of capitalism – which has become misused and distorted – since no one wants to replace private ownership on a large scale and outside limited and temporary exceptions. This core failure is more at issue politically because the GOP now cries “Socialism!” at every turn and, frankly, if I read one more ridiculous, distorted comparison to Europe I’ll barf.
3. The idea that one can compete without creating cost. As you’ve noted, Brad, many of the information issues trace to London’s light-touch regulation – including, it seems, Treasury’s and the Fed’s ignorance of the extent to which Lehman’s demise would cause a dollar shortage for European banks. That light-touch was set up by Britain to attract business and the competitive edge brought in massive capital, drove up real estate prices, pumped money in London financial firms – and apparently enabled AIG’s CDS group. Such an edge also has a cost and now the bill has come due. We can’t delude ourselves into believing actions don’t have consequences.
Brad,
What is the point here? Banks are pretty well defined entities in most jurisdictions. Bank fragility was well understood and the intrusion of practices that well managed investment banks (the ones with management capital at stake) would ban in their own firms was also well-observed, criticized, but not opposed. Without the Chimerica fuelled US housing boom, things would have been different.
And without the root problem of the financial services industry: overcapacity and ambiguous agency (who does management care about? shareholders, depositors? the captive taxpayer?). For some reason no one did something about it. Do not blame the banks. Banks that would not play the musical chairs game would not play at all. The ones that did knew that some would lose. No one expected that the chairs would disappear during the game.
Twofish:
The problem is that the financial industry has been allocating most of the resources to itself. By most metrics from wages to the share of the S&P 500 earnings (source: Paul Kedrosky’s blog), finance plus insurance and real estate just got too big.
And I think you’re confusing Wall Street with venture capital and angel investors.
I do agree that the value is added by efficient allocation of resources. Unfortunately, efficient is what’s missing. Maybe that’s what the financial industry needs, a dose of Wal-Mart. Hell, even the two Bobs would be an improvement.
Larry: The problem is that the financial industry has been allocating most of the resources to itself. By most metrics from wages to the share of the S&P 500 earnings (source: Paul Kedrosky’s blog), finance plus insurance and real estate just got too big.
It’s not clear to me that these statistics mean much. In the 1960’s, a lot of resource allocation decisions were made by middle managers in large companies. In the 1980’s, a lot of these large companies were broken up, and now you had the same sorts of decisions meaning made by people in finance.
Larry: And I think you’re confusing Wall Street with venture capital and angel investors.
No I’m not. It’s all part of one big system. VC firms get their money from hedge funds or are hedge funds themselves, and the money to the VC firm usually flows through an investment bank. Angel investors use private banking in order to keep money available for investment. And the goal of these firms are get large enough so that they can IPO or get bought out at which the investment bank is necessary so that the founding capital can exit.
Larry: I do agree that the value is added by efficient allocation of resources. Unfortunately, efficient is what’s missing.
In some ways US finance turned out to be too efficient. One characteristic of US corporations is that they are completely dependent on financial markets to satisfy cash needs, and having lots of cash lying around is generally considered a sign of incompetence. The problem is that when the markets start to fall apart, then things get very bad, very quickly.
The analogy is that most companies in the US don’t have big diesel generators, because they can rely on the power grid, but when the power gets knocked out, things get very bad, very quickly.
Larry: Maybe that’s what the financial industry needs, a dose of Wal-Mart.
Wal-Mart wouldn’t be possible without Wall Street, since they need investment banks to handle things like letters of credit, bond and stock issuance, and treasury services.
In particular, it’s important to point out where Wal-Mart fits in with the system of securitization, which has gotten this reputation as this evil nasty thing with no redeeming social purpose.
Wal-Mart has about $7 billion in cash and cash equivalents. It doesn’t put that $7 billion in a checking account. What it does with most of that $7 billion is to purchase short term securities such as repurchase agreements and money market funds, and since that cash is not in a checking account, for that money to be put to work, it has to go through the securities market.
Twofish et al, I believe the argument about the financial industry needs to be put into context. People aren’t objecting to the traditional uses of finance, which include what Walmart – no longer Wal-Mart – does with their money. They object to CDO squared and to credit insurance that is a bet made with no insurable interest. No one sensible would argue that mortgage backed securities – which means securitization – is evil. That includes cutting the pile into tranches because those are still directly connected to the underlying interest. But people do object to the next levels of instruments, those which bet on the direction of price for the various mortgage securities, which become casino bets equivalent to betting which rain drop will fall faster on a window.
rien — the banks were pushing the argument that their sophisticated risk management allowed them to operate with more leverage, and that securitization had shifted risk off balance sheet so they could easily survive a “housing” related stress test. some banks (and bank economists) in early 07 were actively hostile to any suggestion that we weren’t living in a goldilocks world of permanently low risk spread and low levels of financial market volatility. I was working for RGE at the time, and I got an earful aobut nouriel’s pessimism and record for being wrong (he thought the us would enter into a recession in 06 when housing turned down … ). I came away convinced that the banks were something other than passive victims …
though i fully agree that they whole buildup of risk couldn’t have happened without non-market inflows from china and other central banks.
I don’t know who you are. From your comments on this blog, I can guess you are some sort of derivatives trader at Goldman Sachs.
You like to think that the financial industry as a whole is ethical, productive and good for everyone and it is a few bad apples that give everyone else a bad name.
But you are hopelessly blinded by your insider’s perspective. In short you have drank the kool aid. I have no doubt that you are an honest and industrious person yourself, but sorry to break it to you, the industry you work in is rotten to the core.
It’d help a lot for insiders such as yourself to acknowledge the scale of the rottenness and corruption, and think about how you’d create a better financial system.
observer: I don’t know who you are. From your comments on this blog, I can guess you are some sort of derivatives trader at Goldman Sachs.
No, but close enough for the sake of this discussion.
observer: You like to think that the financial industry as a whole is ethical, productive and good for everyone and it is a few bad apples that give everyone else a bad name.
No, I don’t believe that at all. I believe that if you give people lots of money to do the wrong things, the wrong things things will happen, so you have to set up the incentives so that people end up doing socially productive things, and that there were all sorts of horrible incentives that encouraged bad behavior.
I don’t think that people in finance tend to be better or worse than any other large group of people, and you get your mix of saints, and crooks and everything in between. Focusing on the personal ethics of people misses the point, since if you replace everyone, you end up with another group of people with moral quality which is about the same.
Also whether or not there are a few bad apples or not is sort of irrelevant. If a few bad people can cause this much damage, then something is very, very wrong with the system.
observer: But you are hopelessly blinded by your insider’s perspective. In short you have drank the kool aid.
It’s interesting that you assume that I believe things that I simply don’t, and then call me hopelessly blinded.
The fact that I work on the inside does change the way that I view the world, but I do try to see beyond my little silo.
Observer: I have no doubt that you are an honest and industrious person yourself,
This makes no sense. If I’m a person that willingly works for an industry as bad as you say it is, then I can’t possibly claim any sort of honesty, and I don’t see why you want to claim that I am anything other than corrupt.
It’s not as if I’m forced to do the work that I do. It’s not as there could be lots of corruption around me, without my noticing.
Observer: but sorry to break it to you, the industry you work in is rotten to the core. It’d help a lot for insiders such as yourself to acknowledge the scale of the rottenness and corruption.
I just tell you want I see. If it’s not what you think I should see, then I’m sorry. I actually don’t see that much rottenness and corruption, probably in large part because I intentionally and consciously avoid situations where there is rottenness and corruption.
Observer: and think about how you’d create a better financial system.
The problem is that if you start with the premise that the industry as a whole is rotten and corrupt, then I should be punished quite severely, and I don’t see how you can avoid that conclusion. If I’m going to get strung up by the lynch mob, then it’s unlikely that I’m going to cooperate irregardless of whether or not I deserve to be strung up.
I dunno. Maybe the fact that I try to surround myself with decent people, is precisely I don’t personally know anyone that makes as much money as FollowTheMoney’s friends.
Brad,
Thanks for your response. Of course banks deserve a lot of blame, but a regulatory environment designed to foster competition (a development that began in the investment banking industry in 1976) without actually removing the main cause of overcapacity: lack of credibly uninsured bank liabilities. Allowing banks to compete with investment banks and under a widely criticized regulatory regime (Basle ! and 2), was stupid. I should add here that the alternative to a (bad) international regulatory standard would have been some form of protectionism. If commercial banks would have been unable to sponsor conduits and trade in commercial paper,and insurance companies unable to make commercial oans or write credit derivatives (except with capital requirements at least at the commercial banking level) the investment banking community would probably be reduced to firms operating on an agency and short term trading basis. Protectionism would then come in if foreign banks would make US domestic loans from their US agencies at terms clearly unfeasible for banks subject to US domestic regulation. That would, of course, have made the international business of US moneycenter banks much more difficult, leading to two influential interest groups (moneycenter banks and investment firms) to support the regulatory regime that contributed to the present mess.
And a situation like that does not reward the virtuous: you either play or fold..