Finance on the Ropes

Wall Street used to adore Mario Batali, the Croc-wearing celebrity chef. Bankers crowded his expensive restaurants and dined on Italian dishes built around piglet alla paesana or Sardinian lamb. In November, however, Batali served up something that made bankers gag. At a Time magazine panel, he compared the financial industry to Stalin and Hitler, decrying how they had “toppled the way money is distributed—and taken most of it into their hands.”

Batali hastily apologized, but not before outraged Wall Streeters made their displeasure known. “Thanks for kicking us when we’re down, MB,” wrote Timothy Chen, a trader at Maxim Group in New York, in a post in the restaurant news section on the Bloomberg terminal. It’s rare to hear such an anguished expression from a Wall Street executive. But then this has been a terrible year for them. Along with being compared to mass murderers by one of their favorite restaurateurs, bankers have had to endure tanking earnings (in October, Goldman Sachs reported its first quarterly loss since the financial crisis), layoffs, and, for those who remain, the prospect of reduced bonuses. On top of all that, a ragtag gang of anarchists, socialists, labor activists, students, and unemployed people spent much of the fall camping out in the park where brown-bagging back-office types usually take their lunch, complaining that bankers were the root of all the nation’s economic ills. “The irony is that protesters are concerned about high bank profits,” says Mike Mayo, a veteran banking industry analyst and author of Exile on Wall Street: One Analyst’s Fight to Save the Big Banks from Themselves. “But profits haven’t been very good this year. The protesters are four years behind. They should’ve been out there with their signs in 2007.”

The recovery in the U.S. has been disappointing for the legions of unemployed people, mortgage holders whose homes are underwater, and banks that build the products that trade on these activities. There’s hardly any demand for structured debt. Before the financial crisis, “there was roughly $1.3 trillion of commercial paper supporting asset-backed bonds,” says Richard Bove, a banking industry analyst at Rochdale Securities. “Now that number is down to $300 billion, which means that there are no asset-backed bonds around that anybody wants to buy.” Initial public offerings have slowed, along with mergers and acquisitions. The industry isn’t making much money on loans, either. Banks can borrow cheaply from the government. But they can’t mark it up much to customers because interest rates are so low. It’s almost enough to make you feel sorry for a class of people who, until now, have been fairly pity-resistant.

The problems of the euro zone only add to their woes. The markets rise when European leaders announce another patchwork solution to their sovereign-debt crisis. They fall when the shortcomings become apparent, as they inevitably do. Traders like volatility as long as the overall direction of the market is apparent. That wasn’t the case in the third quarter; the Dow Jones industrial average swung violently up and down as panicked investors bought and sold on the headlines. Investment banks trading large blocks of securities on behalf of their clients got mauled. In November, Goldman Sachs reported it lost money trading on 21 days in the third quarter. Morgan Stanley did the same on 31 days. As a result of all these factors, U.S. banks are expected to post a decline in revenue growth for the year of 1 percent. “That’s the lowest since 1938,” says Mayo.

Hedge funds aren’t doing any better. In the third quarter of 2011, their returns fell by 6 percent, wiping out $85 billion, according to Hedge Fund Research. It was the industry’s worst quarter since the last four months of 2008, when Lehman Brothers imploded.

Such dismal performance is usually followed by two things: falling stock prices and layoffs. Bank of America’s shares hit a low under $5 in December, recalling the dark days of early 2009 when there was talk of bank nationalization. As of mid-December, financial firms had shed 200,000 jobs, according to data compiled by Bloomberg. And it looked as if their human resource departments were just getting warmed up. “This is something really different,” says Huw Jenkins, a former UBS investment banking chief who is now a managing partner of Brazil’s BTG Pactual in London. “This is a structural change. The industry is shrinking.”

There’s more retrenchment on the way. For all the banking industry’s lobbying efforts, the reforms passed last year as part of the Dodd-Frank legislation are slowly being enacted. Banks are closing their proprietary trading desks to comply with the Volcker Rule, which allows them to execute trades for clients but forbids them from doing so using their own balance sheets. This has had dire consequences for Goldman Sachs. It relied on trading for more than 62 percent of its revenue, as of early November. The government and the industry are still squabbling over the definition of proprietary trading. But this much is inevitable: Wall Street’s most powerful firm will have federal regulators scrutinizing its trades to determine whether they comply with the new rule. Morgan Stanley is in a similarly awkward position. “I don’t see how they can survive,” says Peter J. Solomon, chairman of Peter J. Solomon Co., an independent investment bank in New York. “Well, they’ll survive. But they’ll be smaller, and they are going to be highly controlled.”

Wall Street can no longer afford to blithely take risks as it once did, not when some of the largest banks are trying to resolve suits filed by the SEC and angry investors are accusing them of stuffing mortgage-backed securities with bad loans during the subprime boom. They are also in talks with numerous state attorneys general about their use of “robo-signing” mortgage processors to feed their collateralized-debt-obligation factories. “The industry has to rethink the way it does business,” says Bove. “That means it’s going to fire more people. It’s going to change internal rules and regulations because nobody wants to get sued again.”

It doesn’t sound like fun. No wonder the happiest bankers aren’t the ones on Wall Street but those at smaller regional operations that offer their depositors old-fashioned checking accounts and loans. “We have a Bank of America across the street,” chuckles David Provost, CEO of Talmer Bank & Trust in Troy, Mich. “They are our greatest source of new depositors.”

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