Synopsis
Chasing Goldman Sachs You know "what" happened during the financial crisis ... now it is time to understand "why "the financial system came so close to falling over the edge of the abyss and "why "it could happen again.""Wall Street has been saved, but it hasn't been reformed. What is the problem? Suzanne McGee provides a penetrating look at the forces that transformed Wall Street from its traditional role as a capita... Full description
Extrait
CHAPTER 1
From Utility to Casino: The Morphing of Wall Street
Alan “Ace” Greenberg’s firm may have collapsed underneath him, but even in the darkest days of 2008, the eighty-one-year-old investment banker’s legendary chutzpah was visible on Bloomberg’s business television network. “There’s no more Wall Street,” Green-berg, the former CEO of Bear Stearns, declared, adding that it had vanished “forever” in the rubble.1
It’s fashionable on Wall Street today to talk wistfully—or in a tone of reverential awe—about investment banking as it was practiced during what is now seen as a kind of golden era. Greenberg’s comments, though more hyperbolic than most, are one example.
The changes over the course of 2008 were so dramatic that Green-berg believed the Wall Street he helped forge no longer existed in any kind of recognizable fashion. Some nostalgic Wall Streeters view the investment banking landscape of the 1960s, ’70s, and early ’80s as a kind of utopia: investment banking as its purest, before the 1987 stock market crash, the collapse of the junk bond market, and Gordon Gekko made Wall Street seem slightly reckless and disreputable. To others, Greenberg among them, the golden era is the more recent past, when investment banks such as Bear Stearns saw their revenues and profits soar as they catered to the emerging powers on the Street, hedge funds and giant buyout funds, and watched their bonus payments and personal wealth climb even more rapidly.
The balance of power has certainly shifted on Wall Street, and new products, players, and technologies have transformed it. But Greenberg’s comments were directed at the collapse of specifi c institutions: the shotgun wedding of his own firm with JPMorgan Chase, the bankruptcy filing of Lehman Brothers, and, the same weekend, the flight of Merrill Lynch into the arms of Bank of America. Greenberg most likely knew about the behind-the-scenes wheeling and dealing orchestrated by Ben Bernanke and Hank Paulson that involved every conceivable combination of every Wall Street firm with every one of its rivals ( J.P. Morgan and Morgan Stanley? Goldman Sachs and Citigroup?). The desperate rush to save the financial system from utter collapse had resulted in the kinds of merger negotiations—however short-lived—that would have seemed laughable only weeks earlier. To Greenberg, still reeling at the collapse of his own firm (which had, after all, survived even the 1929 market crash and the Great Depression), that must indeed have felt like the end of Wall Street.
Wall Street, however, is more than just a set of institutions with big brand names, however old and venerable. At its heart, it is a set of functions, and those functions remained intact even in the midst of the crisis. Two days before Greenberg delivered his epitaph for Wall Street, a small Santa Barbara company, RightScale, raised $13 million in venture capital backing from a group of investors led by Silicon Valley’s Benchmark Capital.2 RightScale’s secret? It was in the right business—cloud computing, a way for customers to reduce their IT development costs by using Internet-hosted services—at the right time. Despite the dramatic headlines focusing the world’s attention on the plunge in the stock market and the deep freeze that hit the credit markets, parts of Wall Street’s core business were still functioning, albeit in a more muted fashion. In the final three months of 2008, venture capital firms invested $5.4 billion in 818 different deals, bringing the total for the year to $28.3 billion. That was down a bit from 2007, when venture firms—partnerships that have made fortunes backing companies such as Amazon.com and Google and lost smaller amounts backing stinkers such as Pets.com—put $30.9 billion to work. But it’s still more than they invested in any year from 2002 through 2006.3 By the fi rst anniversary of the collapse of Lehman Brothers, even the high- risk world of junk bonds was back in business. The sign? Beazer Homes, one of the worst-hit home- building companies in the entire industry, was battling not only the collapse in the real estate market but also a federal fraud investigation. Yet Wall Street found enough investors willing to close their eyes to those risks and invest $250 million in junk bonds issued by the company to help replenish its coffers.4
What Does Wall Street Do, and Why Does It Exist?
The reason for the Wall Street bailout—the explanation for Hank Paulson being desperate enough to literally drop to one knee in front of Nancy Pelosi in the White House and plead for her help passing the initial $700 billion rescue package—is that Wall Street’s functions are essential to the economy. According to reports that were leaked to the media almost immediately, Paulson begged Pelosi not to “blow it up” (referring both to the bailout package and the fi nancial system itself ) by withdrawing the Democratic Party’s support for the rescue effort. “I didn’t know you were Catholic,” Pelosi quipped, referring to Paulson’s kneeling before her, in an effort to lighten the atmosphere before blaming the Republicans for the gridlock.5
By saving some of Wall Street’s institutions—those viewed as the strongest or the most important to the system—the architects of the bailout and many of the subsequent reform packages hoped to preserve intact the system that enables capital to flow more or less smoothly through the economy the way power flows through the electrical grid or water through a municipality’s water and sewer system. Regardless of what Main Street was thinking—and communicating to their members of Congress—Wall Street isn’t incidental to what happens in the rest of the economy. Without Wall Street to perform its fi nancial grid functions, it would prove almost impossible to raise capital to repair bridges, finance new companies such as RightScale, and keep others—such as Beazer Homes—afl oat.
What we tend to think of as Wall Street—the stock market, the investment banks, and the newer entities such as hedge funds—is really only the visible tip of a much larger iceberg that is the entire financial system. Collectively, these institutions help ensure that capital continues to move throughout the rest of the “money grid.” Sometimes they do this by providing a market for participants to undertake basic buy or sell transactions; on other occasions, they negotiate or devise solutions to more complicated capital- related questions, such as helping a company go public or sell debt (a process known as underwriting) or working with it to establish and achieve the best price possible in a merger negotiation.
That intermediary function is alive and well, most visibly at the New York Stock Exchange, which occupies not only the epicenter of Wall Street at the corner of Broad and Wall Streets but the heart of its role as a financial utility. On its sprawling trading fl oor, traders go about their business in much the same way their earliest pre decessors did in the naves of Amsterdam churches, executing the purchases of blocks of shares for their clients, who these days could include an individual trying to sell 100 shares of General Electric or Microsoft inherited from a grandparent or a mutual fund manager trying to reduce his holdings in Amazon.com in order to buy a stake in Alibaba.com, a Chinese counterpart. Exchanges trading stocks, futures, and options contracts as well as commodities remain one of the most heavily regulated parts of Wall Street because of the essential role they play in a large, geographically scattered, and diverse community.
Not convinced of the value of Wall Street’s functions and processes? Imagine you are a retiree in your seventies, living off your investment portfolio. The wisdom of your decision to invest in Microsoft in the mid-1980s has become clear; now you’re counting on being able to sell some of that stock at its current market value in order to cover your living expenses for the next six months. Wall Street’s processes make that relatively simple—all you have to do is place an order to sell the stock at the market price with your broker or custodian (say, Charles Schwab) and ask for the money to be transferred to your bank account when the trade is settled in three days’ time.
Now, imagine that there was no Wall Street. For starters, you’d have a hard time establishing a fair price for that stake in Microsoft without the stock market, with its countless numbers of buyers and sellers meeting in cyberspace to decide each minute of the day what value they ascribe to Microsoft’s shares and thus what price they are willing to pay for your stock. Even if you thought you knew what your shares were worth, how would you find a buyer and persuade her that your analysis is right? Would you go door-to-door in Miami or Los Angeles? Put up an ad on Craigslist? (In Vietnam’s over-thecounter market, that is exactly what happens; you then arrange to meet the buyer on a street corner to swap the shares for cash.) And if you found a buyer, could you be certain that you would be paid in full and on time, so that you could pay your own mortgage and purchase your groceries?
Money has existed for millennia, ever since people recognized that barter was an inadequate method of exchange. The stock exchange, just a few centuries old, was the next logical step as society’s financial needs became more complex. The first exchanges were established in wealthy trading cities such as Hamburg, Antwerp, and Amsterdam. Here, by the early sixteenth century, there was a signifi cant concentration of wealth in the hands of merchants and noblemen, all of whom had an interest in putting it to work in new and different kinds of enterprises in the hope of diversifying and making still more money. These communities traditionally were also home to cutting-edge commercial enterprises, ranging from new technologies such as printing to global trading ventures to the East Indies.
Investors willing to back these enterprises—most of which could take years to pay off—needed a secondary market: a place where people who were interested in buying or selling shares in ventures could meet each other or find an intermediary to help them with that transaction. For a while, Amsterdam’s church naves served that purpose, along with the open-air wharves on Warmoesstraat near the city’s old church, or Oude Kerk. The first formal stock exchange in Amsterdam opened its doors in 1610; between noon and 2:00 p.m. each business day, members were expected to show up and buy and sell on behalf of the general public—in other words, to provide liquidity to the secondary market.6 By 1688, the Amsterdam exchange already looked a lot like the trading floor of the New York Stock Exchange in its twentieth-century heyday; seventeenth-century stock jobber Joseph de la Vega, in his dissertation on the fi nancial markets of the time, entitled Confusión de Confusiones, famously described the scene as one in which “handshakes are followed by shouting, insults, impudence, pushing and shoving.” (Perhaps it was this familiar atmosphere that led so many former professional football players to pursue second careers in the trading pits of the Chicago Board of Trade and the Chicago Mercantile Exchange.)
There probably has never been a time when people didn’t complain about how the financial system worked—or failed to work. Nevertheless, the United States, as Alexander Hamilton, the country’s fi rst Treasury secretary, realized, would need a smoothly functioning fi nancial system as part of its struggle to emerge as a viable nationstate.7 Hamilton’s initiatives included creating the country’s fi rst national or central bank, the First Bank of the United States, to replace myriad institutions within each of the thirteen original colonies, each of which had its own monetary policy and issued its own currency. Hamilton’s goal was financial order and transparency, necessary if the new country was going to be able to repay its war debt and fi nance its growth by investing in new industries.
Wall Street, the narrow thoroughfare in lower Manhattan that owed its name to its former role as the northern border of the sixteenth- century Dutch colony of New Amsterdam, benefited from many of Hamilton’s efforts to create the infrastructure of a national fi nancial system and emerged as the heart of the new country’s fi nancial markets. It was here merchants chose to hang out on street corners to swap their ownership interests of government debt or the handful of start-up companies, such as canal construction ventures, that would form the core of the United States’ new economy. (If you wanted to trade in the bonds newly issued by Alexander Hamilton’s fl edgling Treasury Department, you’d have to know which lamppost on Wall Street to stand under.) Eventually, the introduction of New York state regulations banning curbside haggling as a “pernicious” practice drove these early Wall Streeters indoors. Some two dozen dealers gathered under a buttonwood tree to sign a pact that served as the foundation of the New York Stock Exchange. First housed informally in a Wall Street coffee house, the exchange moved to a room at 40 Wall Street in 1817, paying $200 a month in rent, before relocating to the quarters it now occupies, just across Wall Street from Federal Hall. Today, the original Buttonwood Agreement, a tiny sheet of yellowing paper, is on display at the Museum of American Finance a few doors away at 48 Wall Street, the building that once housed the Bank of New York, also founded by Hamilton himself.
“You know, if Hamilton came back to life, I don’t think he’d be all that surprised at the way the financial system has evolved,” says Dick Sylla, the Henry Kaufman Professor of the History of Financial Institutions and Markets at New York University. A silver-haired, slightly built man, Sylla appears unruffled by the dramatic changes that have taken place on Wall Street, smiling wryly at a display at the museum featuring Citigroup’s now-reviled leaders—Robert Rubin, Sandy Weill, and Charles Prince. But then, for him as for Hamilton (about whom he is writing a book), America’s financial system was never about a single institution, however large. “It’s all about the functions that the various institutions perform, rather than what names they go by or where their headquarters happen to be,” Sylla explains. “Hamilton knew that there would be bubbles and periods of chaos. But if over the long run the system as a whole performs its function of allocating capital and allowing us as investors to diversify our portfolio, to not put all our eggs in one basket, it is doing what he wanted it to do.”
The Nature of the Money Grid: The Intermediary
Wall Street, in its totality, involves more than what happens on the floor of the New York Stock Exchange or within the walls of any single investment banking institution. It has become a labyrinth of many different groups and institutions, all of which have one thing in common: they make the whole money grid work more smoothly and more efficiently. Many of them work hundreds or thousands of miles away from Wall Street itself. In Tacoma, Washington, Russell Investments devises stock i...
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