Although I definitely don't agree with Farrell that the "only way to truly rein in the power of the modern financial giants, aka the too-big-to-fail club, is for governments to embrace balanced budgets," it certainly would help, and it highlights the symbiotic relationship between out-of-control gov't spending and too-big-too-control Wall Street banks which must trade all that gov't debt. (This goes for Europe and Japan, too.)
Since the giant financial firms gorge on massive government debt issuance, a prudent fiscal regime would curb the investment bankers' power
By Chris Farrell
April 28, 2010 | Bloomberg Businessweek
The future of Wall Street certainly seemed bleak on Apr. 27. Executives from Goldman Sachs (GS), the world's most profitable securities firm, were grilled by the Senate Permanent Subcommittee on Investigations for their behavior during the housing market crash. The stature of the firm—and by proxy, Wall Street—are diminished, no matter what comes of the Securities & Exchange Commission's allegation that Goldman defrauded customers in creating and selling a synthetic security during that crash.
But another meeting that day in Washington suggests the possibility of a brighter business future for the major Wall Street firms: the National Commission on Fiscal Responsibility & Reform's gathering at the White House. The bipartisan blue chip group has been charged by President Barack Obama with devising ways to reduce the federal government's $1.4 trillion deficit and bring down its $7.8 trillion debt. The meeting served as a sober reminder that it will take years to bring down the massive amounts of debt the government will be issuing in coming years—assuming that a bipartisan deficit-reduction measure can be agreed upon and passed into law.
Here's the thing: History may not repeat itself, but it does rhyme. In which case the increase in government debt should be a good thing for Wall Street. After all, it isn't just the U.S. that's issuing lots of government debt that needs to be distributed to investors worldwide. Following dramatic actions to shore up their beleaguered economies during the Great Recession, sovereign debt levels of the Group of Seven industrialized nations as a proportion of gross domestic product are nearing 60-year highs, according to the International Monetary Fund.
The numbers are striking. The IMF projects that gross general government debt will reach 78% of GDP in 2010 in the United Kingdom, 77% in Germany, 84% in France, 93% in the U.S., and 227% of GDP in Japan. According to the 2010 league tables compiled by Bloomberg, the leading players in global bonds are Barclays Capital (BCS); JPMorgan (JPM); UBS (UBS); Deutsche Bank (DB); Bank of America Merrill Lynch (BAC); Goldman Sachs; Morgan Stanley (MS); Citigroup (C); Credit Suisse (CS); and HSBC Bank PLC (HBC). The reputations of these Wall Street titans may be tattered at the moment, but governments will need them to market and manage all that debt.
IN THE '60S: "MAHOGANY ROLLTOP DESKS"
A critical factor behind the rise of modern Wall Street was a major shift in fiscal policy during Ronald Reagan's Presidency. In the post-World War II period, government debt had shrunk as a proportion of GDP. Even in the late 1960s, Wall Street was a small place, still recovering from the debacle of the 1930s. When Roy Smith, a market historian and professor at New York University's Stern School of Business, went to Goldman Sachs in 1966 after graduating from the Harvard Business School, the U.S. investment banking industry was dominated by Morgan Stanley. Investment banking consisted of some 20 partnerships that averaged 500 employees apiece, with an aggregate capital base of less than $100 million.
When Smith arrived on Wall Street, "many of the partners sat in one large Dickensian room behind matching mahogany rolltop desks so they could easily communicate with one another when they needed to," he writes in his latest book, Paper Fortunes: Modern Wall Street; Where It's Been and Where It's Going.
Wall Street started changing during the high-inflation years of the 1970s and the deregulation of commissions. With the rise of supply side economics in the early 1980s, government debt volumes surged and Wall Street expanded with them. All that debt had to be distributed, sold, and traded in large volume. "It had a lot to do with transforming the business model of the firms from advice into being traders for its own sake," says Smith. "You can't be a market maker without being a trader."
The effect was dramatic. For the first eight decades of the 20th century, financial assets grew at about the same rate as GDP, except in wartime. Subsequently the total value of financial assets as a percent of GDP has grown more than twice as much as in the previous 80 years, according to calculations by McKinsey & Co. In 30 years, the Wall Street firms grew from small private partnerships to publicly traded global behemoths.
BIG DEMAND FOR BAILOUTS, REFINANCINGS
To be sure, marketing government bonds is a low-margin business. And there were plenty of other things keeping Wall Street busy, from rising stock market trading volumes to merger & acquisition mania. Still, the "growth of government debt might have encouraged all of these other activities by providing safe and liquid securities that could be sold, repo'ed, or otherwise collateralized to fund the other activities," muses Richard Sylla, economic historian at New York University.
Governments are going to need the set of skills honed over the decades by Wall Street financiers. It isn't just the volume of debt. Sovereign bailouts, refinancing, and other financing maneuvers are complicated. "All the major firms are comfortable dealing with U.S. government debt and foreign bonds," says Smith. "It's a great business opportunity for the next several years."
It all implies that financial reform is the solution. The only way to truly rein in the power of the modern financial giants, aka the too-big-to-fail club, is for governments to embrace balanced budgets. That's what Tyler Cowen, economist at George Mason University and Marginal Revolution blogger, recently wrote about the U.S.
"There's a different way to think about the bailouts, namely that the U.S. government stands at the center of a giant nexus of money-raising, most of all goes to finance the U.S. government budget deficit and keep the whole show up and running," Cowen wrote. "If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take."
He's right, and not just for the U.S. In the meantime, Wall Street looks to thrive once again on debt volume and market turmoil. Plus ça change ….
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