In the war zone that is modern finance, the demise of Lehman Brothers in September 2008 was the shot heard 'round the world.
Three years later, and investment banks from New York to Brussels are still facing the same problems. The ultra leveraged model of sell side finance is dying. A growing number of traders are saying that it is time to bury it. Regulators are playing hardball, some say maybe too hard, in their effort to prevent future asset bubbles. In the process, jobs will be lost. Many bond traders will have to downsize. Individual lives will be changed, for better or for worse. Careers will be destroyed along with the very institutions that built them.
The dismantling work is not going to end in 2012. The deleveraging of investment banks is going to continue for "the rest of our adult lives", says one managing director of a European headquartered investment bank that has watched its market cap collapse from around a billion to $200 million in a matter of two years.
In 2008 and 2009, Washington spent over $700 billion bailing out General Motors and many investment banks. But while GM is surviving, and paid off its debt last year, investment banks are still falling apart and will likely have to shed parts of their assets in order to stay in business.
"I get resumés from kids from NYU and Harvard that come in for internships and I tell them all: 'run away as fast as you can'. This industry is fucking crap. It is never going to be the same. It can't be," a managing director at Nomura Securities told me recently. Nomura, a Japanese investment bank, is going to downsize hardcore. Entire departments will evaporate. The company posted its first quarterly loss in two and a half years on Tuesday because of the slump in investment banking revenues. As a result, top executives in Tokyo said Nomura will triple its cost-cutting target to $1.2 billion to cope with market conditions that were as tough as they were in 2008.
Ironically, outside Nomura's World Financial Center office building is the construction site for the new Freedom Tower. It will stand at 1,776 feet tall, chosen as the year that marks the country's independence, and should be completed by 2015. Hopefully, by then, the market would have recovered.
In that same city, MF Global filed for bankruptcy. Two hundred and fifty years ago, the company started out in the boring sugar trade, acting essentially as a middle man selling sugar from the source to the king of England. It survived stock market crashes and two World Wars. But it didn't survive leverage and the European sovereign debt crisis. It's one thing to buy bonds for $900 that end up being worth $700. It's another thing to borrow 10 times the value of those bonds in order to buy them in the first place.
Over the last few months, the Financial Industry Regulatory Authority has reviewed MF Global's holdings of European sovereign bonds and the sophisticated manner in which it was trading those bonds. Because of the risk factor involved with the ongoing tanking of Italian, Spanish, Portuguese and Greek bonds, FINRA qualified those bonds as non-sovereign, or basically equivalent to riskier corporate debt. They told MF Global that it needed more collateral to cover those bonds, and that's when things went south for MF Global.
To make matters worse, a relative unknown player, Greenwich, Connecticut-based Interactive Brokers, was willing to buy out MF Global's futures merchant and broker dealership until IB's due diligence found a discrepancy in MF's client accounts to the tune of $700 million. MF is now facing an investigation and IB backed out of the deal, leaving MF without a white knight. One trader told me that MF Global, with its 2,847 employees, will likely cease to exist in the next three weeks.
Eventually, MF Global's clients will look elsewhere. Volume on the futures exchanges shrank by more than half because MF client speculators were out of the market, Barron's reported.
The company is disappearing before Wall Street's eyes....
Keep Your Weight Down
"I'm in the job market now and I'm focused on Asia and Latin America banks. They've been through this process already. You have to go where the money is and it is not here. My advice to the sell side is to keep your weight down and your hair dyed," said the MF trader who could not be named.
The never-ending human need to find someone to blame has turned to former Federal Reserve Chairman Alan Greenspan. It's not the first time he was pointed out as the Alpha and the Omega of the 2008 financial crisis. Once known as the Oracle back in the late 1990s, Greenspan's loose money policy is being blamed on the Street as the nicotine in the tobacco; as if no one really believed it could be that addictive.
Leverage is like that: an addiction. When there is no patience to make a million, you borrow 10 million and hope to eek out 10% to make that million in the markets. With interest rates declining throughout the 2000s, and a Western and Japanese unified monetary policy of easy money greasing the wheels, investors geared up into equities on margin. Ten percent gains weren't that difficult. Margin debt increased. Regulations changed, making Wall Street more friendly to speculation. Books have been written about this. A forest full of articles have been published on this as well. While Main Street investors with a home brokerage account can buy on 1.5x margin, often required to deposit at least 50% of the price of the asset, investment banks were easily 40 times leveraged, borrowing on top of assets based on another asset based on another asset until it all gets to a point like it did in 2008, or again in 2011 Brussels, where Dexia Bank -- bailed out three years ago -- is on the verge of being nationalized. Dexia's leverage was three times the size of the Belgium economy. It would take three Belgiums to pay for Dexia's debt. That's not unique. It would take an equal number of Frances to pay off Societe Generale's debt. Dexia's stock price was down 90% from its first bailout in 2008. Societe Generale, when it is not busy watching its traders go to jail, has to raise money. The market is not convinced it can do it sustainably, or long term. This is the sell-side universe. And it is zipping along into a black hole.
"I would not want to be on the sell side of this business," says Paul Simon, chief investment office at Tactical Allocation Group, a $1.5 billion wealth management firm far from Wall Street in very unglamorous Birmingham, Michigan. "The financial services industry is over-brokered. The amount of capacity on the sell side does not reflect the demand. It is completely out of whack. The business is going to be very different five years from now," he says.
Franchises will either shrink voluntarily or be forced to shrink.
In World Financial Center building 2, palm trees stand tall and warm. It's a faux paradise. This isn't Rio. This is New York City on a 55 degree day. A colder Hudson River flows about 200 yards from the atrium at WFC 2. The State of Liberty looks small in the distance. My Nomura director sips a Starbucks coffee and looks down at some clothing store. "The U.S. is all about the service industry. I guess it is better to lose your job in the financial services than in retail services," he tells me. "I'll be alright if I lose my job. I make three times what their managers make," he says, pointing his chin towards the clothing store. "It's getting much harder to make a living," he says.
To some, these six and seven figure "fat cats" in the financial markets had it coming. Not only is the party over, but those outside of the business have been left picking up the broken bottles and stepping on the shards of glass, slicing themselves open without any health insurance to pay for the stitches. But to anyone who has any empathy, it is not hard to see that a man making $250,000 a year and a man making $50,000 a year are equally levered out beyond their means. The $250,000 a year junior bond trader lives in a home worth 8 times his salary just like the $50,000 a year UPS driver. Marriages crumble. Country club memberships are canceled. Kid's have to go to state schools. They may be becoming more middle class, while the middle class may be becoming more poor. But just as the middle class lost manufacturing jobs, investment bankers are losing jobs on the sell side of the business, too. They are all climbing up a mudslide.
Is the buy side any better?
Sell Side or Buy Side?
The financial services industry also has the buy side. Mostly the realm of money managers and registered investment advisers, so long as entrepreneurs need to manage risk, and retirees and rich people need to preserve capital, there will always be a buy side. Their money has to go somewhere, and someone will have to advise them what to do with it. It's a slower road to high income for the financial services professional, and one with a much lower turnover rate so jobs are hard to find. But it is one sector of the business that some guys, including those from the imploding MF Global, are considering.
"The sell side is a frightening place to be," says Michael Roche, 52, a senior vice president at MF Global in charge of emerging market fixed income strategy. I spoke to a small handful of MF Global traders off record. I asked Michael what he thought about the buy side because I know he used to work there around 20 years ago. He says it's not as collegial, not as fast, but it is more stable and not out of the question for many of his colleagues, himself included. "It favors experience, a longer investment horizon, and likes people with a lot of history in the market."
The buy side of the market has never been as flashy. But maybe less flash, more substance is what the industry needs. Less of "do everything" and more of "do less", whereas doing less means you pick your market and your specialty and you stick with it. Revenues for trading is down, revenue from M&A is down. Why do both?
"From a business standpoint, if you're living in a volatile market it is better to be in a more stable business that's more concerned about the long term," says David Donabedian, chief investment officer of Atlantic Trust, the $17.5 billion private wealth management firm of Invesco. "When our client's portfolio's go down, that doesn't mean they are no longer high net worth individuals," he says. Yet, from where he sits, the number of high net worth individuals in the U.S. isn't going up. It's stabilizing, and may be going down. The rich may be getting richer, but the U.S. is not creating a large number of rich people. "There is less wealth creation in the U.S. today," Donabedian says.
Some might blame the investment bankers for that. One thing is for certain, many of them are paying the price for leveraged risk. When it comes to the financial service industry, the sell-side of the business is in a bear market for the foreseeable future because of that risk.
Last year, the Bureau of Labor Statistics estimated that the roughly 5.7 million people working in financial services will grow 12% by 2018. That may very well be the case and the Freedom Tower owners are hoping for it so they can rent out the floors that are currently being erected a few blocks away from the Occupy Wall Street movement in Liberty Square. But what side of the business will grow? Regulatory service providers helping companies through the new, ever changing rules? The wealth management division of big emerging market banks? Or will the over-brokered investment banking market make a comeback in the next six years?
If you ask someone at Dexia, Societe Gerale, Nomura, MF Global and even brokers that I have spoken with at Gradual Investimentos in São Paulo, their mood soured in 2008 and hasn't improved yet.
See: Getting Over Our Over Levered Selves--Forbes
MF Global Files For Bankruptcy After Bad Bets On European Debt--Bloomberg Businessweek
What Happened At MF Global--Reuters
Dexia Inches Towards Break-Up --Bloomberg
Societe Gerale Deleveraging To Meet Capital Ratio Targets--Wall Street Journal
UBS To Fire 3,500 In Investment Banking Unit--Business Insider
Nomura To Ax 5 Pct Of European Staff--Reuters
US Financial Services Industry--Securities Industry and Financial Markets Association, July 2010
