
What good is Wall Street? - philk
http://www.newyorker.com/reporting/2010/11/29/101129fa_fact_cassidy?currentPage=all
======
SeanDav
A well written, balanced article. As someone who has spent many years in the
banking/investment industries on both the "buy" and "sell" sides I can say
that there is no doubt in my mind that banks are an essential part of a
healthy economy. I can also say without any doubt that banks have been allowed
to go way too far and that it is all about the short-term rewards.

------
dpatru
The real problem is not that firms took innovated and took risks, it's that no
one seems to have been held responsible. All the "failed" banks, investment
houses, and businesses should have been allowed to fail. They should have been
liquidated to pay their creditors and their assets allowed to be bought out by
firms that acted responsibly. Instead, the irresponsible were/are bailed out,
and their managers are allowed to continue operating.

The lesson is: Take risks. You will pocket profits right away and bailouts
will cover any downside.

~~~
swombat
That's a nice, plausible position to take, and very popular too. Well done for
saying what the people want to hear.

Now, taking a more realistic view, when Lehman collapsed, the stock market
went into free-fall. The links between all those financial corporations are so
thick that if one of them is allowed to fail, it threatens to bring the whole
thing down.

If the governments of the world had not, with uncommon speed and purpose,
stepped in and "bailed out the banks", money would, at this point, be more
useful as fuel in a stove than as a bartering device.

The idea of letting failing companies fail is valid as long as they don't
bring down the whole system. If you let companies grow to such a level of
interconnectedness and size that they have the potential to destroy the whole
world economy in a matter of months, and then you suddenly realise that they
are that big and they are failing, the correct course of action is not to let
them fail, but to sort out the short-term problem (i.e. bail them out) and
then work on the long-term problem (cut down their size and complexity so they
can once again fail without destroying everything).

Until a proper regulatory framework is in place to prevent financial companies
from getting so intertwined and large that they can bring down the whole house
of cards (for that's what _every_ economy is, a house of cards based upon the
common trust that it's all going to work out ok), it is in fact very
reasonable to suggest that a good medium-term step is to get those companies
to "stop innovating", given that their incentives are such that they will
inevitably bring the whole thing down if allowed.

This is a more realistic view than the "let them fail" silliness.

~~~
darose
+1.

Paul Krugman of the NY Times wrote extensively both during the crisis and
since about the correct way to handle this situation:

1\. Put the failing bank into "receivership". I.e., a "receiver" (temporary
managerment) appointed by the government takes over the company and tries to
salvage it.

2\. Fire the original management team. I.e., the ones that got them into this
mess with their excessive risktaking. Good. They should suffer the
consequences of their bad management decisions. That's capitalism.

3\. Take on whatever additional debt or equity financing is necessary to turn
the company around - without paying any regard to the positions or desires of
the current stockholders. The current stockholders' positions' will likely get
diluted to nearly worthless. Good. They should suffer the consequences of
their bad investing decisions. That's capitalism.

4\. After the company is turned around, take it out from under government
receivership, hire a new management, and (if needed/appropriate) launch it
public again via an IPO.

There's a long, established history for handling failed banks this way (read
up on the S&L Crisis), and it's the proper way to keep an institution alive
and out of bankruptcy, without rewarding the management and stockholders who
brought it to bankruptcy in the first place.

Krugman often pointed out, though, that the Obama administration was too
scared to go this route - perhaps because they were worried about the absurd
accusations of "socialism" that the Psychotic Right would undoubtably have
started screaming about.

So instead, they chose to reward the management and shareholders that caused
the problem, by using government money to help prop up the value in their
worthless company. Moral hazard indeed! Privatize all the profits, but give
all the losses to the public. And socialism is the evil here?!?!?!?

~~~
brc
Your comment loses value through the unmitigated bias showing through. You had
me until 'Psychotic Right' as though viewing the problems through a left/right
filter is the explanation.

The fact is we'll never know what would have happened if large companies were
allowed to fail, because they weren't. It might have been worse, it might have
been better. For sure it would have been worse in the short term, but these
issues should be measured over the medium to long term. One of the messages
that has been sent out with the current handling is that there is a Fed put on
any high risk adventure, and that's not good.

Personally I think that there is something to be said for the 'bandaid'
approach. Not sticking something over the top to cover the problems, but a
short sharp shock of pulling it off and let the problems be.

The problem with the bailouts is that they cover over the fact that some
companies were allowed to fail. Lehman, for one. And the world didn't stop
turning. Sure, this caused liquidity problems and risk premiums to escalate
dramatically, to the detriment of employment and the real economy. But it's
foolish to pretend that this isn't going to happen anyway. The problem with
Krugman and others is that they believe a lack of demand is the problem. They
view the problem through this prism, and as such they come up with solutions
that match their world view.

Others (including me) say that perhaps the problem is excessive debt. And
until that excessive debt is eliminated from the system, productive companies
are unable to make use of the resources tied up in the unproductive ones
currently taking shelter with public money. You say the institutions should be
kept alive, I say that they should be destroyed and the buildings and staff
and infrastructure released to new institutions who can find a way to be
competitive.

I believe you shouldn't look at the problem in terms of a company or bank
failing. That's just the symptom. Once the debt had built up excessively, it
was only a matter of time and method for the companies to fail. The problem
was watering down of regulation that had stood the test of time for 70 years,
and regulators becoming toothless. So far, this hasn't been fixed.

This is a not a left/right blue/red debate. It is a debate as to the level
that central governments should take in directing and manipulating markets.
Neither 'side' is debating this. Nobody will try and defend central planning
and a command economy, because it is comprehensively proven as a failed model,
yet we seem to be reversing backwards into this situation on the say-so of a
bunch of people who couldn't see the problems headed their way. They don't
seem to realise that controlling the fundamentals of money (supply and price)
causes wrong investment choices through inappropriate price signalling. And
then they try and correct those choices by further fiddling with central
control instead of letting the chips fall where they will fall. Because
they're going to do this eventually - no amount of bailing out will fix a
fundamentally out-of-date business model.

~~~
swombat
Lehman was indeed allowed to fail, and the crisis that its failure caused was
sufficient to ensure that no government would be stupid enough to try that
experiment another time. Of course, this is all theorising, but the general
thinking in financial circles is that the government had to step in with
monster bailouts to restore confidence precisely because Lehman was allowed to
fail.

------
iwr
Wall Street organizations, in their present form, are functionally bankrupt.
Having been bailed out, the clearing of bad debt never happened. This
effectively trapped a large amount of capital in their vaults. In addition,
the government is doing everything possible to funnel more productive
resources into these black holes.

The real systemic risk was in throwing good resources after the bad. The
"contagion" was other governments being spurred to do the same.

------
ig1
Some of this article is well written however the attacks on innovations such
as ABS an CDOs is tacky, yes they haven't done well, but that's the nature of
innovation. You're always going to have some innovations that do well and
other that do badly, the only way you'll find out is through execution. They
were both designed to solve practical problems in liquidity and price
discovery.

Picking through individual failures and saying the whole system is bad on that
basis is like saying startups are worthless because WebVan failed.

~~~
jbooth
I think the point is that they actually don't solve any practical problems in
liquidity or price discovery.

Does anyone on earth care about the price of lumber within even a 24 hour
window? Why should we care about a sub second window? We don't. Wall Street
refers to the high frequency game as "taking the dumb money". I call it
"ripping off the value investors who actually serve a role in the economy".

Finance serves an important function in the economy, routing money to where
it's needed. Are they doing a better job of that now than they were in 1985?
Not really. So why are they extracting 10X the money in bonuses and profits?

~~~
yummyfajitas
_Wall Street refers to the high frequency game as "taking the dumb money"._

This is a rather strange thing for them to say, since it's usually the smart
money types complaining about HFT.

It used to be that mutual/pension funds and other institutional investors
could hide their big trades in noise - the market would adjust slowly, and
other people (retail investors, smaller shops, assorted other suckers) would
absorb the price impact of the trades. Now they are complaining they can't do
this anymore.

[http://www.advancedtrading.com/exchanges/showArticle.jhtml?a...](http://www.advancedtrading.com/exchanges/showArticle.jhtml?articleID=219401479)

(The authors of this article work for a "rent our 'screw the retail guys'
algorithm" outfit.)

Basically, assorted HFT shops catch them in the act, trade ahead of them, and
split the profits with the former "suckers" [1].

[1] Crossing the spread means that the passive investors in the market are
making a premium.

[1] See also this article: [http://www.zerohedge.com/article/pipeline-
executives-confirm...](http://www.zerohedge.com/article/pipeline-executives-
confirm-abusive-hft-practices-including-potential-front-running)

~~~
jbooth
Well, you know a lot more about HFT than I do, I just know that I've heard
several people refer to their trading practices as taking the dumb money,
including a one-guy algo shop that sounded similar to how you've described
your work.

At the end of the day though, I'm still stuck on my 1985 story --
compensation, profits, bonuses, etc have skyrocketed since then. But what good
have all the newfangled instruments done for the rest of the economy? Doesn't
seem like much. So is it just rent-seeking?

EDIT: RE: hiding the big trades in noise. What's wrong with that? Why should
they have to develop a special HFT algorithm in order to simply move shares
around without getting their lunch eaten? This is exactly the kind of value
extraction I'm talking about. HFT shops have now created a huge expense for
these retail shops that didn't exist before.. are the financial markets
functioning better as a result? No, they're just sucking more money out as
transaction costs.

~~~
yummyfajitas
Comp/bonuses went up for some. It went to zero for many others. In 1985, banks
had armies of line workers processing trades, managed by officers making
decent money. The average comp at a bank might be the average of 1 officer and
100-500 low level line workers. It would be better than other office jobs, but
not great.

In 2010, the officer specs out business requirements after talking to traders
and regulators, sends the high level work to IT and the CRUD apps to
Bangalore. 475 of the 500 line workers have been replaced by a data center in
Nutley, NJ, 5 remain in the US handling cash wires and other time-zone
sensitive work, and 20 work via email out of an office park in Pune.

For obvious reasons, the average comp of 1 officer + 3 IT guys + 5 US line
workers is going to be far higher than the average comp of 500 grunts + 1
officer.

Additionally, for many reasons (IT being one of the biggest ones), it's also
vastly easier today to strike out on your own than ever before. In 1985, if
you wanted to quit and start a hedge fund, it was tough. Today, a hedge fund
can be operated by 3-4 guys + servers. Banks are forced to pay their traders
enough money to prevent them from quitting and doing exactly this.

(Remind you of another high comp industry, with established players giving out
big comp packages to retain talent?)

Edit (in response to your edit): _RE: hiding the big trades in noise. What's
wrong with that? Why should they have to develop a special HFT algorithm in
order to simply move shares around without getting their lunch eaten? This is
exactly the kind of value extraction I'm talking about. HFT shops have now
created a huge expense for these retail shops that didn't exist before.._

When you make a large trade, there will be a price impact. This is unavoidable
- if you are selling millions of shares, supply went up, and price must drop.

In 1985, institutional investors (not retail investors) tried to make sure
that _other people_ (their counterparties) suffered the price impact. They
would sell shares at full price, retail investors (i.e., my Mom) would buy
from them, and then shares would go down once the market figured out supply
dramatically increased.

In 2010, some HFT shops will sell to my Mom at a favorable price, and then buy
from the institutional investor after prices go down. This benefits the HFT
shop and retail investors at the expense of the institutional investor. I'm
not saying this is good or bad, I'm saying it benefits "dumb money" (little
guys who can't afford to rent an algorithm) at the expense of "smart money"
(Goldman, Vanguard, Calpers Pension Fund).

[edit2: just a disclaimer - specific numbers/cities should not be taken as
precise. The data center might be in Jersey City or Brooklyn, Pune might be
Cebu or even Baltimore, and there might have been 250 or 1000 line workers
rather than 500.]

~~~
jbooth
This is an awesome convo BTW, thanks for providing all the detail about the
industry.

Regarding our high comp industry vs theirs.. we've reinvented the world at
least twice since 1985, and like I said, I haven't seen a reinvention of
finance in any positive way. If they're that much more efficient now (and I
agree that they are along the lines you're saying), where are the savings for
the rest of the economy? I'm all about the TD Ameritrades of the world where I
can do an $8 trade, that's providing value and they deserve every penny they
earn. But it seems like most of the hedge funds are just playing games to
extract money from less sophisticated investors.

Regarding your average comp comparison -- that's fine, I'm all about profiting
from efficienbut what about the aggregate comp? Is that higher, too?

~~~
yummyfajitas
_Regarding our high comp industry vs theirs.. we've reinvented the world at
least twice since 1985, and like I said, I haven't seen a reinvention of
finance in any positive way._

In almost every financial service that existed in 1985, margins have been cut
to the bone (the main exceptions being M&A and IPO services). The commission
on stock trades is now $0-8, it used to be $150, as you note.

When businesses need futures/options (mainly for hedging purposes), they often
just buy them on the open market rather than contacting a GS/MS/JPM rep and
paying through the nose for the privilege.

Regarding hedge funds/private equity, Warren Buffet and others have commented
that there are very few hidden gems left, particularly gems detectable by
financial/technical analysis. I.e., good businesses are getting more
investment.

 _Regarding your average comp comparison -- that's fine, I'm all about
profiting from efficienbut what about the aggregate comp? Is that higher,
too?_

It's a good question. Top traders get more, but they also tend to earn more.
Good IT is certainly vastly cheaper than armies of line workers, and HFT is
cheaper than human market makers. More financial services are provided today -
my understanding is that credit cards were hardly pervasive in 1985, and no
one would cell you a phone on quasi-credit like they do today.

I have absolutely no idea and I'd be very skeptical of anyone who claims to
know.

------
eml
... At Goldman, it has been reported, nearly a thousand employees received
bonuses of at least a million dollars in 2009. Not surprisingly, Wall Street
has become the preferred destination for the bright young people who used to
want to start up their own companies, work for NASA, or join the Peace Corps.
At Harvard this spring, about a third of the seniors with secure jobs were
heading to work in finance. Ben Friedman, a professor of economics at Harvard,
recently wrote an article lamenting “the direction of such a large fraction of
our most-skilled, best-educated, and most highly motivated young citizens to
the financial sector.”

Read more
[http://www.newyorker.com/reporting/2010/11/29/101129fa_fact_...](http://www.newyorker.com/reporting/2010/11/29/101129fa_fact_cassidy#ixzz1612hb0Zy)

\- The unintended consequences of the Federal Reserve system of monetary
distortion.

------
chopsueyar
It's gotten Michael Douglas at least 2 paying gigs.

------
alexyoung
Well, the Ferengi make regular pilgrimages to Earth's Wall Street, to them
it's a holy site of commerce. That probably brings in a lot of tourism money.

~~~
eru
Sources?

~~~
iwr
<http://memory-alpha.org/wiki/Wall_Street>

------
BSousa
Didn't really read it all the way through, but for some reason, it is only me
that finds it weird that the publish date is November 29, 2010? Is this an
error or intentional?

~~~
michael_dorfman
Magazines (like the New Yorker) are usually dated a bit into the future, so
that they look fresh on the news stands. At my local magazine shop, almost of
the monthly magazines are already on their December issues, and some of them
have been out for a week or two.

Have you really never noticed this before?

------
patrocles
What good is Google? or OkCupid? or any matching service?

For those who have nothing to seek, these services are indeed an environmental
scourge. ;)

