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By now you’ve probably read Greg Smith OpEd at the NY Times on why he left Goldman Sachs.  

At first I read it and I thought “good, someone is daring to bring ethics into the discussion”.  But upon re-reading it I ended up thinking “what bullshit”. 

Mr Smith , thirteen years is long to realise what an investment bank is for.   Investment banks (assuming they don’t use their own balance sheet for a minute) mediate between those who need capital and people who have money to invest, between those who need to hedge risk and those who seek it, and between those who buy companies and those who build it.  Their profitability is predicated on how well they do this reliably, and how much margin they can take by being in the middle.  To attack them for optimising profits (and thinking of customers as sources of profits) is misunderstanding their nature.  Mr Smith woke up and smelled the coffee.

The employees of investment banks are incentivized purely on the annual net margin they can generate.  Think about it : have a great year, kill it, get $2M or $10M and be made for life.  No one else is tooled like they are to optimise profit everywhere it can be made.  They have better mathematicians, better systems and better salesmen.  They have no incentive to care about any of the externalities that they create.

In that sense Darth Vader’s hilarious “Why I left the Empire” is the best possible response.

What happened in the run-up to the financial crisis is that EVERYONE thought they could create value out of thin air and forgot the basics.  Financial engineering does not generate value that was not there to start with.

  • As an asset manager, you can invest in bonds, equities, commodities, hedge funds and so on.  What you cannot do is invest in a structured note that links the payout to a basket of commodity options and hope somehow you will make more money, when what you are clearly doing is enabling your investment bank to fudge the returns profile and make a higher margin.  Greed makes you buy things you don’t understand.
  • As a bank you cannot hope that selling off all your risk through securitization but keeping the equity portion (i.e. the toxic piece) really releases capital.  What you’re doing is playing with the capital adequacy regulations so you can be more leveraged.  And driving more margin to your investment bank.
  • As an individual you cannot do continuous equity release on your mortgage and buy plasma screens.  What you’re doing is speculating on the housing market with the place where you want your kids to grow.

Investment banks are what they are.  They are not and will never be aligned with their clients.  They want to maximise their margin by being the most inventive middleman they can be.  That is their M.O. and there is nothing moral or immoral about it : it simply does not enter into the equation.  It’s what they do and by the way they are a necessary and important cog in efficient financials markets.  What with have today is the tail wagging the dog, but don’t blame them for being good at what they do.

I left investment banking after seven years and pretty much as soon as I understood this.  I wrote about some of the shit we used to do to give you a sense of how everything can be arbitraged if people let you.  Why did I leave ?  Because it’s hardly aspirational, because it was clear we were going to destroy value and because I subscribe to notion of sustainability and, to use Umair Haque, Betterness.  I subscribe to the Manifesto.  

If you want to change the system, and we should, here what needs to happen:

  1. The industry as a whole should accept Behavioural Economics and Chaos Finance and stop trying to be so smart in devising increasingly complex instruments that cannot be understood / modelled / controlled.
  2. Every asset manager (the guys who invest your pension money) should be compensated on a long-term incentive package and assets held should be fully understood and manageable by the investor.  Most should have long-term buy and hold strategies instead of constantly trading on results.
  3. Every market (e.g. credit derivatives) should be standardized, made transparent and disintermediated by technology.  Take margins out, bring transparency in.
  4. Commercial banks who deal with people’s life savings should be heavily regulated and treated for what they are, utilities.  I don’t want the people providing my mortgage to have expertise in anything other than whether I am a good credit risk or not.
  5. As for investment banks, they should continue to do what they do best: raise capital, run M&A, and so forth.  How profitable they are depends on how profitable you want them to be.
  7. What happened in the wake of the financial crisis is one of the great swindles of all time.  To take a leaf out of J.P. Rangaswami’s awesome LIFT talk on “Tech Vs People” (@jobsworth), the losses that came out of the financial crisis were socialized and the profits were privatized, in the exact opposite manner in which the open source community functions, where successes are shared with the community that then improves and propagates the gains whilst losses remain private (you project tanks, you just wasted your time).

Amongst investment banks, Goldman Sachs is a well run firm that stays (usually) on the right side of the law.  They are better than many of their competitors and insanely good at what they do.  Asking them to be agents of change in building a better world is misplaced – they are just not designed for that.  However how much power and money you decide to give them is mostly down to you.

Again borrowing from JP, “you don’t get a medal for critizing, you get a medal for how constructive your criticism can be”.  Mr Smith woke up to the reality of investment banks — instead of demonizing them, he should think about how you redefine their importance and take power away from them.

Let’s attack the cause, and not the symptom.

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