Where Does Wall Street Go Now?

Paper Fortunes: Modern Wall Street:

Where It's Been and Where It's Going

By Roy C. Smith

St. Martin's Press; $35 The economy may be healing from the Great Recession, but much of the financial-services industry remains on its sickbed. Once-mighty firms either got bailed out by taxpayers, swallowed up by others, or simply vaporized. Many of the survivors are weighed down by multibillion-dollar loan portfolios gone bad. In Washington and on Main Street, financiers are viewed at best with suspicion, at worst with loathing—yet they continue to dole out billions of dollars in bonuses.

It's a bleak landscape. Yet Wall Street will reinvent itself, writes Roy C. Smith in Paper Fortunes: Modern Wall Street: Where It's Been and Where It's Going. "One lesson learned over the past forty-four years is that to endure, Wall Street has to continuously change." Unfortunately, his book doesn't give a fully satisfying answer to how Wall Street will reinvent itself.

Smith graduated from Harvard Business School in 1966 and took a job at Goldman Sachs (GS). He estimates that only 5% of his class of 800 went to work on Wall Street, probably because the industry's reputation still hadn't recovered from the debacle of the 1930s and its pay wasn't competitive with other leading businesses. Smith started out at $9,500 a year, with no mention of a bonus. (Among his classmates who went to Wall Street was New York Mayor Michael Bloomberg—founder of Bloomberg LP, which owns Bloomberg BusinessWeek—to Salomon Brothers.)

SMALL WORLDBack then the investment banking business was tiny, comprising some 20 partnerships with an average of 500 employees and an aggregate capital base of around $100 million. Morgan Stanley (MS) dominated the blue-chip securities business, yet in the mid-60s "many of the partners sat in one large Dickensian room behind matching mahogany rolltop desks so they could easily communicate with one another when they needed to."

Smith made partner at Goldman, retiring from the firm in 1988 to take up his current teaching position at New York University's Stern School of Business. He was a player, and a close observer as the U.S. financial industry evolved from a fragmented community clustered in lower Manhattan into a global behemoth dominated by large, publicly traded firms that earn more than half their income outside the U.S., with foreign nationals making up over half their workforce.

It's a breathtaking industry bildungsroman, full of flamboyant personalities, shrewd risk-takers, catastrophic blunders, and failed ideas—such as the financial supermarket, best illustrated by Sandy Weill's creation, Citigroup (C). At heart, Smith is a friendly critic. He describes the industry's many mistakes, recognizes its dependence on government bailouts, and highlights grievous flaws in its bonus system and other practices. But he also believes it's the entrepreneurial dynamo of America, a business that offers opportunity to those with little more than brains and pluck. Walter Bagehot, the 19th century editor of The Economist, is a big influence on his thinking. Writes Smith: "The real power of the market, [Bagehot] went on to suggest, is its ability to offer the benefits of leverage to those working their way up in the system, whose goal is to displace the men at the top."

It's a powerful theme, but Paper Fortunes doesn't quite make the case. The rise of Wall Street helped knit together an evolving global economy, but it's not clear how much all the trillions of dollars in financing meant to everyday entrepreneurship. Smith also doesn't grapple enough with what he thinks should come next. It seems clear that too many smart people went to Wall Street in recent decades and did much more to enrich themselves than society. So what's to prevent that from continuing?

Nonetheless, Paper Fortunes is a worthy book. Anyone interested in financial regulatory reform would be well advised to consult it. And Smith's finely detailed account of the industry's postwar history, while sometimes a bit dry, offers invaluable perspective. (After perusing it, for example, one feels that the current enthusiasm for bringing back the Glass-Steagall Act—the 1933 legislation that sundered commercial and investment banking—amounts to little more than an exercise in nostalgia.) Smith also touches on a point too often neglected these days: What changes will the market impose on the industry? The financial supermarket has fallen from favor. So have ultrasteep leverage ratios at finance firms. He thinks the combination of regulatory and shareholder pressure may even lead the industry to shrink for the first time in modern history.

Whatever form Wall Street takes, it will continue to lure more than its share of high rollers. That's just as it should be, Smith argues—even allowing for the dark side of the culture of greed and risk. But the reader may finish the book with a different feeling: that Wall Street needs to be contained.

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic networkWall Street's Appeal DimsB-school grads aren't flocking to Wall Street the way they once did. In 2008 a record 41% of Harvard's MBA grads landed jobs in investment banking, private equity, and hedge funds. This year the number was down to 28%. The all-time low was 1937, when only 1% of the class—three grads—took jobs in the securities industry.To view the statistics, go to http://bx.businessweek.com/harvard-business-school/reference/

    Before it's here, it's on the Bloomberg Terminal.