Saturday, November 15, 2008

Turning Wall Street Partnerships Into Corporations: "It's Laissez-Faire Until You Get In Deep Shit"

The era that defined Wall Street is finally, officially over. Michael Lewis, who chronicled its excess in the book "Liar’s Poker," returns to his old haunt to figure out what went wrong, and writes about in "The End." Here's an excerpt from the last page:

John Gutfreund did violence to the Wall Street social order—and got himself dubbed the King of Wall Street—when he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation. He ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of the firm’s founder, who had made Gutfreund C.E.O. only after he’d promised never to sell the firm, had told me.)

He lifted a giant middle finger at the moral disapproval of his fellow Wall Street C.E.O.s. And he seized the day. He and the other partners not only made a quick killing; they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders.

But it made fantastic sense for the investment bankers. From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.

No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.

Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of the other Wall Street firms—all said what an awful thing it was to go public and how could you do such a thing. But when the temptation arose, they all gave in to it.” He agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government [aka the U.S. taxpayer, see comments]. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle. He was out of the game.

6 Comments:

At 11/15/2008 11:40 PM, Blogger Patrick Henry said...

Wow...fantastic article.
Who would have thought that Wall Street is greedy??
Seriously though, this is just the excuse the new administration needs to incorporate new laws on Wall Street. Sarbanes-Oxley is nothing compared to what is coming next.
Yikes!

 
At 11/16/2008 9:29 AM, Anonymous jrich said...

When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government.

That should be "the problem of the U.S. taxpayers." It sounds so innocuous when it's worded as a problem of the "government."

 
At 11/16/2008 9:38 AM, Blogger Mark J. Perry said...

jrich: Thanks for that comment, please see the updated post!

 
At 11/16/2008 12:23 PM, Blogger the buggy professor said...

1) Mark: This may be the most important and illuminating article on the current state of the US economy --- and the larger world economy --- you've ever linked to . . . certainly on the financial side.

......

2) The Lewis analysis of Wall Street's behavior adds up to a monument to a combination of raging greed and arrogant self-delusion --- Hey, our genius program-writers have already allowed for all the risks and hedged against them in a variety of foolproof ways, guys! --- that has brought down the entire global economy and its most important country-actors.

....

3)Enter the culprits.

It's hard to know who is worse: the financial geniuses who a variety of regulators and Secretary of Treasures (back to Lawrence Summers) said were so brilliant that any regulation of their new financial instruments would be absurd and a throwback to the early Pleistocene days of economic life (AKA, the period of the industrial revolution and its fall-out down to the 1980s); or the swollen-head geniuses themselves; or the flim-flam artists who were only interested in a fast-buck; or free-market enthusiasts who believed rabidly innovative financial markets were self-regulating and had the interests of their creditors at heart . . . well the list is very long, no?

Not to forget the 30 trillion dollars of footloose capital in the world in 2000 --- which took centuries of economic development to create and which doubled to 60 trillion dollars held by avaricious, ill-informed, and devil-may-care risk-taking oil-rich gangster governments, real or virtual financial firms, hedge-funds, or rich wildly optimistic brain-lame sheiks, drug-lords, gangsters, dictators, and a few legitimate but foolish pollyannaish investors caught up in a sustained surge of euphoria --- that was desperate for investment outlets . . . a clear sign of huge imbalances in the global economy, and aggravated by 24-hour pc-linked financial markets.

One thing for sure: the rest of us --- taxpayers, consumers, workers, managers, and business owners (not to mention governments dependent on tax-revenue) --- will be paying the price for this gala financial-extravaganza in the years to come.

.....

4) Besides reading Michael Lewis's brilliant writing and current article --- I myself have read all his other books other than the one on baseball --- the visitors here to Mark's site should read the 200 or so comments left by posters at the portfolio.com site, most of whom, it seems, have had experience in Wall Street financial firms or their equivalent elsewhere.

They are all very illuminating. click here

.....

Thanks again, a terrific link.


Michael Gordon, AKA, the buggy professor

 
At 11/16/2008 3:58 PM, Anonymous qt said...

One of the finest pieces of writing I have come across in a while. Fascinating look at the inside of this disaster.

Thanks for the link. Look forward to tracking down his other books.

 
At 11/17/2008 10:15 AM, Blogger 1 said...

Its interesting what Michael Lewis has to say in that Portfolio commentary, especially his comments about Meredith Whitney...

Obviously Meredith Whitney is a bright lady but she was hardly the first to "take a hard look at the crappy assets"...

Here's an article on Meredith Whitney that I stumbled across while looking for something about Ms. Whitney from 1440 Wall Street: Death Threats Rattle CIBC Analyst...

There is a comment at the end of the article by one 'David J Phillips' who said: "Casting aside the hubris of ego. It is still a tiring exercise to watch as others get credit [because of well-oiled PR machines] for stories I broke months earlier. For example, CIBC banking analyst, Meredith Whitney, is currently the toast of Wall Street, for predicting the demise of the sub-prime market"...

Sounds a bit like, 'sour grapes', right?

Well dang! Mr. Phillips did indeed make a similer comment that Ms. Whitney made but he said so on his blog site back in '05: HRB is of investing interest because approximately 50 cents of every dollar in revenue is generated by mortgage services. This operating segment is engaged in the origination of non-prime mortgage loans through an independent broker network, the sale and securitization of mortgage loans, and the servicing of non-prime loans. [ed. note. non-prime means "sub-prime," which means "high-risk."] Of the $12.6 billion in loans generated in the quarter-ended October 31, 2005, approximately 96.6% of this volume originated in sub-prime lending...

The point I'm making here is that the everyone involved in the mortgage game probably knew that there was a festering problem long before the supposed need for a bailout surfaced in Washington D.C....

 

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