The Plague of Stupidity on Wall Street -- Part II


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When we last left you, MAMA MORTGAGE was dying (slowly), the U.S. Economy was being flushed, and the taxpayer was getting an enema…  (See: The Plague of Stupidity on Wall Street -- Part 1)
 
It doesn’t take genius to know that Wall Street has potholes.  Even by the mid-90’s the old fashioned ways of making money – taking deposits and making loans – had already become generic commodities for commercial banks.  With the rise of globalization, the de-regulation of major currencies, and enhanced global capital flows, banks began to seek new ways in which to generate growth and profitability.  With the assistance of repealed Depression-era legislation such as the Glass-Stiegel Act, commercial banks began to view investment banking as an important new business opportunity.
 
Thus, an era of aggressive consolidation ensued, as commercial and investment banks searched for vast “White Spaces” to augment the absence of fundamental growth in their base business.  This led to the biggest buying binge in a generation; as storied firms like Bankers Trust, Shearson, Dillon Read, Solomon Brothers, and First Boston were bought by Deutsche Bank, Citigroup, Credit Suisse and Nation’s.
 
As commercial banks sought to “integrate” their expanded business models across newly-acquired investment banking platforms, they applied a standard playbook in their efforts:  cost reduction, synergy, economies of scale…  This philosophy proved to be a killer.  Not only did they lose great people (as is always the case), but they destroyed the dynamic cultures which fueled the Emerging Growth Economy. 
 
But the most lasting negative effect of the consolidation by the “Bulge Bracket” Wall Street firms is that they destroyed the business model of emerging growth investment banking.  A by-product of the consolidation among financial institutions in the late-1990’s is that profits earned through underwriting (e.g. sales, trading, and syndication declined by 85%.  Since this market-making function comprised the cornerstone of the business model, the inability to sustain liquid capital markets for growth stocks has led to catastrophic results. 
 
The theory offered at the time was that – despite the 85% decline in trading commissions – the largest banks would be able to MAKE IT UP IN VOLUME… 
 
Yeah, right!
 
It did not take long before everyone realized the fallacy of that strategy.  Then, because their traditional business (that deposit taking, loan making thing) wasn’t good, and because their newly-acquired investment banks had been reduced to ashes, these banks decided to leverage their own balance sheets in order to attain Nirvana.  The assumption was that “If Goldman Sachs can do it, so can we…”  Then they started buying mortgage-backed securities, and the rest …  is… history.
 
BOTTOM LINE:  Without a valid capital market for emerging growth companies, a critical component of our financial system has been lost. Over time, the absence of liquid capital markets will have the further effect of preventing new capital from being deployed to the most vibrant parts of the U.S. economy, and it will result in fewer great companies being created.  This, in turn, strikes at the core of our nation’s competitive interests.
 
Consider what the mainstream media has said recently about this exact issue:
 
 
In the end, we believe that someone will figure out the problem.  They will recognize this vast, market disruption caused by the convergence of inefficient market forces.  They will discover how much value can be unleashed in creating a solution to this market disruption.  They will re-create a vibrant marketplace in which the securities of the world’s most promising companies can be bought and sold by the most sophisticated institutional investors.  They will re-invigorate entrepreneurs.  They will create challenging, well-paying jobs.  They will pioneer fast-growing, profitable industries.  They will generate wealth for themselves, their families and their communities.
 
They will resurrect the Four Horsemen.