(This guest post previously appeared at NewDeal2.0)
As a deep economic recession looms, securities held by Wall Street banks lose value. Even worse, because values cannot even be determined, the securities cannot be liquidated for needed cash and major banks fail. Investment vehicles created by the bankers to aggregate assets become insolvent.
State and local governments are threatened by financial ruin. The White House authorizes mergers of major firms despite deep concerns about propriety. The Federal Government injects funds into the banks to avert a financial system collapse and is joined in the bailout by wealthy and well-known individuals. After the financial system crisis passes and the resulting recession runs its course, congressional hearings targeting bankers focus public opinion in support of major financial system legislation.
This was the Panic of 1907, not 2008. The great “trust buster,” Theodore Roosevelt, personally authorised J. Pierpont Morgan’s US Steel to acquire teetering steel companies to avoid their bankruptcies, consolidating US Steel’s dominance of the steel industry. The government injected $35 million into the banking system — all that was possible at the time — but this was not enough. Morgan convened a Saturday meeting with the leading robber barons and bankers at his Manhattan home and literally locked them in his study. He released them the next morning after they signed on to a deal he brokered to save the financial system. Later, Morgan was castigated (probably deservedly) at the congressional “Pujo Hearings” for his role in creating the circumstances which led to the debacle. Morgan’s associates blamed the stress of the hearings for his death a few months later. The ultimate result of the hearings was the creation of the Federal Reserve System.
Was Morgan a hero or a villain? Probably, he was both.
Historically, the leaders of Wall Street have occupied this dual role. Enormous wealth allows them advantages in the accumulation of influence and power. They have existed on the knife edge of fairness. Wall Street is usually involved when business practices lead to economic crises. Typically, millions of people are injured by events that defy their understanding. Wall Street “fat cats” are often the last culprits standing and are obvious targets of the angry public.
But at its best, Wall Street served an important function. It provided the wherewithal for growth of every industry from railroads to information technology, vastly increasing the well-being of all Americans. In times of crisis, bankers have worked to preserve economic stability. Sometimes, they have been genuine altruists, accepting the moral responsibilities that go along with their positions of wealth and power. But, altruistic or not, they understood their enormous stake in the long-term vitality of the economy. Preserving the health of the economy was simply good for business.
When I arrived at Goldman Sachs, John Weinberg headed the firm. It was a partnership of professionals then, not a publicly traded corporation, and the partners’ wealth was largely invested in the firm. I saw this Marine veteran of the Pacific campaigns many mornings on the elevator with a muffin perched on a Styrofoam coffee cup, having just arrived at 85 Broad Street in his Ford (Ford was a long-time personal client). His demeanor was closer to the guy behind the counter at the deli than the titan of Wall Street that he was. But, when he spoke, he was both incisive and wise. His motto for Goldman Sachs was, “Be long term greedy, not short term greedy.”
This was genuine. The firm promulgated “Our Business Principles,” and the bankers bought into it. We included these in every presentation and were convinced that clients and potential clients must be persuaded that a firm with such fine principles could be trusted. Like Marines, we were convinced that we were the best of the best. But, wisely, the culture was structured to tamp down arrogance and hubris. Peer reviews became a ritual in which team play and client service were key factors. The firm installed co-heads of many groups, demanding cooperation of them. (Younger bankers predictably referred to them as “cone heads.”) The practice included the heads of the firm (for instance Weinberg served with John Whitehead, who retired just after I arrived). Goldman Sachs became almost a cult.
The concept of having a stake in the long term health of American business was not unique to Goldman. At Goldman, it was just a more overt part of the culture, perhaps disguising the direct self interest involved. Since the time of J.P. Morgan, the end result was the same whether the motives were expressed as the common good or as stark self interest. What was good for a healthy and growing economy was essential both to the basic business of Wall Street and the prosperity of the people.
Trading was always part of Wall Street, the counterpoint to investment banking. Investment bankers advised clients on capital raising and mergers and acquisitions. These activities are collaborative and essentially serve the client’s interest. As a result, long-term relationships and service to the client are essential to success in investment banking. In contrast, traders each have a book of long and short positions. Trader successes and failures are far more personal and immediate. The goal is not to help a client, but to strike a favourable deal with a counterparty. There were legendary struggles between bankers and traders for leadership of Wall Street firms. For the most part, however, the bankers ran the firms.
The world shifted. Trading exploded, largely fuelled by information technology. It seemed that every number on earth could be divided by every other number in real time. Everything could be priced, and, once priced, could be traded. Markets were deregulated and carved into pieces, each representing a trading opportunity. The Wall Street firms, with their enormous capital resources, could dominate more and more of the price points in the American economy. Software programs could be written to access electronic trading platforms so that the enormous force of the trading houses could be brought to bear without the inefficiency of human intervention. It seemed that a business model relying on dispassionate exploitation of immediate opportunity had been perfected.
The golden rule kicked in — “He who has the gold rules.” The predominance of trading profits reversed the balance of influence in favour of the traders. Clients were no longer just clients; instead, they were counterparties to be dealt with at arm’s length. In the end, the traders achieved Nirvana — using asset pools, they were able to synthesize their own clients as sources of securities to trade. The business of trading, focused on short-term profits, became dominant on Wall Street.
The American economy has lost something in all of this. Wall Street’s capital markets business serves us best when it is aligned with the long-term growth of the economy. Without this alignment, long-term stagnation is threatened. We need more Morgans and Weinbergs and fewer trade bots.
If the people perceive an offsetting benefit, they more easily tolerate the accumulation of wealth by bankers whom they may otherwise dislike and distrust. Wall Street’s support of the corporate engine for growth in jobs and investment opportunities can appear to be a reasonable, if sometimes unfair, deal. A business model that focuses on profiting by exploiting price efficiencies in risk pools of pre-existing assets does not generate the same benefit. The well-documented plight of the middle class suggests that this may be more substantive, rather than just a problem of public perception. It is clear that the public tolerance of banker wealth is tenuous.
This Wall Street metamorphosis was a response to the new environment and will persist until outside forces intervene. Recalling the value of Wall Street’s historic interest in long-term economic growth is not just an exercise in nostalgia for a lost era. Advanced trading practices constitute a relentlessly efficient means to deploy capital in great quantity instantaneously. If the premises behind trading strategies are flawed, however, the consequences are magnified. It is relatively easy to hire quantitative geniuses to construct algorithms and measure conditions with great precision. The decision of what to measure and the prudent use of the results is another matter. Short-term mentality is a problem. When things go wrong, and they will, this mentality assures that the damage is immediate and monumental.
The only rational choice for the economy as a whole is to curb trading practices and to align interests of Wall Street and the public. One way to align interests is to assure that bankers suffer appropriately alongside the public when the risks of their trading activities are realised. Perhaps, if trading practices are curbed and the risk of loss is shared, Wall Street’s business of raising capital for long-term growth will ascend relative to trading. The alignment of interests in long-term growth between Wall Street and the public might then become a greater force.
Bankers would be wise to see that this realignment is ultimately in their interest, even if it adversely impacts immediate profits. Today’s reform effort may be blunted through influence on Senators and Congressmen. But a viable contract with the American people is the only way to preserve the business over the long haul.
Be long term greedy, not short term greedy.
Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co.
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