Has Wall Street Been Tamed?
Chris Hentemann has two pieces of art on the walls of his corner office in midtown Manhattan. One is an oversize photograph of the cockpit of his twin-engine Beechcraft Baron. The other is an Andy Warhol print of Muhammad Ali with his fists cocked.
For Hentemann, a rail-thin money manager who has spent 25 years in finance, the two pictures capture the duality of Wall Street. It’s an industry where you need to manage risk with precision and discipline, but it’s also one driven by audacity, ego and the killer instinct. Or at least it used to be.
In an era defined by a populist backlash against rapacious capitalism, the business of finance has lost its mojo. An industry that used to celebrate the invisible hand of the free market, that once showered shareholders and employees with unprecedented wealth, has been chastened by $284 billion in fines over the past eight years. While Wall Street has long prided itself as a hotbed of innovation, today it’s ensnared in a web of rules to prevent bankers from once again threatening the global economy. Profitability and compensation are falling as forces unleashed by the 2008 financial crisis take their toll.
“The more the regulators push, the more they’re turning banks into financial utilities,” says Hentemann, 48, a former head of structured finance at Bank of America Corp. who now runs a $1.5 billion credit-focused hedge fund called 400 Capital Management. “But after what happened in the crash, can you blame them?”
The crackdown didn’t seem to matter to supporters of Democratic presidential candidate Bernie Sanders, who called for the breakup of too-big-to-fail institutions. Now the Republican Party platform and the final draft of the one approved by Democrats call for reinstatement of the Glass-Steagall Act of 1933, which separated commercial and investment banking. If enacted, the measure could break up JPMorgan Chase & Co., Bank of America and Citigroup Inc. The 17 million Britons who voted last month to quit the European Union didn’t care that their nation’s financial-services industry, which accounts for 8 percent of the economy, might have to move some operations overseas.
That’s sobering news for a business that dared to hope the post-crisis reckoning was drawing to an end. For eight years, the men and women who work in finance have been playing defense. More than half a million jobs have vanished from the world’s biggest banks since 2008, data compiled by Bloomberg show. Top-tier hedge funds and money-management firms are dropping fees and cutting employees to stay competitive.
With new capital requirements and tougher stress tests looming, bank chieftains probably will be squeezing even more expenses from their organizations for years to come. This year, revenue at investment banks in the U.S. and Europe will shrink by one-fifth compared with 2010, to $212 billion, according to Boston Consulting Group. Finance pros are confronting a reality they once deemed unthinkable -- the rollicking game they played for so long has been tamed.
As government watchdogs tighten their grip, a sputtering global economy and a horde of fintech startups assailing the castle walls are forcing changes few foresaw in the wake of the crash. Influential bankers such as JPMorgan Chief Executive Officer Jamie Dimon and Banco Santander SA Chairman Ana Botin are investing millions of dollars in ventures to defend their turf from interlopers and win over millennials who live their lives on smartphones. Even the 322-year-old Bank of England is making a move: In June, Governor Mark Carney announced the launch of a fintech accelerator.
“It’s a once-in-a-lifetime shift,” says Vikram Pandit, who, as CEO of Citigroup from 2007 to 2012, led the definitive global financial supermarket. “The architecture in banking is evolving from conglomerates into smaller, nimbler, specialized providers. This isn’t just technological, it’s a shift in business models.”
For all the efforts to rein in the financial industry since 2008, it does have a record of shaking off disasters, from the U.S. savings and loan crisis of the 1980s to the dotcom bust of 2001. Scandals have engulfed the biggest investment banks in recent years, from subprime mortgages to the rigging of the foreign-exchange market to helping wealthy clients sidestep taxes. But Wall Street almost always finds a way to adapt to new rules, bewitch investors with new products and bolster its bottom line.
“This is a sector that has periods of calm, but we shouldn’t assume that surges of recklessness and outright fraud have been wiped away,” says Phil Angelides, who served as chairman of the Financial Crisis Inquiry Commission, a panel appointed by Congress in 2009. “There is always a clear and present danger of that type of behavior returning.”
This clampdown doesn’t look like it will end anytime soon. Instead, the industry is changing at a structural level. Not a month passes without a bank or broker-dealer announcing another business shutdown or market retreat. Credit Suisse Group AG and Deutsche Bank AG recently hit the reset button on top-to-bottom reorganizations, and Barclays Plc announced in March that it was withdrawing from an entire continent, Africa, after 91 years. Even Goldman Sachs Group Inc., which has watched its shares drop 23 percent in the past 12 months, has been humbled. In April, it started offering consumers online savings accounts. The price of admission: $1.
Brexit compounds the pressure on financial firms by casting London’s future as an international financial capital into doubt. Even as British banks weigh plans to offshore operations such as clearing to Continental Europe, investors have found another reason to bail from their stocks. Barclays and Royal Bank of Scotland Group Plc have each lost about a fifth of their value since June 23. The vote prompted the government to push back by two years the sale of its 72 percent stake in RBS, which was nationalized in 2008 to save it from insolvency. Likewise, British taxpayers will have to wait on the sale of their 9 percent stake in Lloyds Banking Group Plc., which has lost about a quarter of its market value since the referendum.
No precinct in the industry is being whipsawed more than fixed income. While stock trading went electronic long ago and now moves at light speed, the $8.4 trillion U.S. corporate bond market is relatively unchanged since Michael Lewis played Liar’s Poker with his pals at Salomon Brothers in the 1980s. The corporate debt game is still dominated by big broker-dealers, and 80 percent of trades are still executed by phone, according to Greenwich Associates.
But the one-two punch of regulation and technology is softening up this bastion of 20th century finance. The 2010 Dodd-Frank Act in the U.S. and new global capital requirements have forced banks to cease borrowing at 30 to 50 times their capital to make proprietary bets in the markets and juice bonuses. The Federal Reserve and its counterparts in Europe stress test lenders every year.
Meeting the capital requirements has made it less profitable for banks to play their time-honored role as middlemen in fixed income. Last year, companies issued $1.5 trillion in debt, double what they sold in 2008. Yet primary dealers have decreased inventories of bonds to help buyers and sellers trade, according to the Federal Reserve Bank of New York.
As a result, there’s less action on trading floors. Profit from dealing fixed income, currencies and commodities, or FICC in industry parlance, has dropped 56 percent globally since 2012, to $26 billion, according to Boston Consulting Group. One out of three bond traders have been fired in the past five years, says research firm Coalition Development. This harsh reality is turning an eat-what-you-kill culture that prized risk-taking into one that’s guarded and paranoid.
“Today it’s play it safe, play it conservatively, don’t rock the boat,” says Heather Hammond, co-head of the global banking and markets practice at executive search firm Russell Reynolds Associates.
Even as traders see their friends fired, banks are bringing in battalions of compliance lawyers, accountants and even spies from the CIA and British intelligence to watchdog them. Like something out of “The Matrix,” new reg-tech startups are releasing algorithms into the datastream of banks to hunt for behavorial patterns that anticipate rogue trades before they happen.
While star performers still pull down high-seven-figure or eight-figure pay packages, quiet trading desks mean smaller rewards for the rank and file. The average compensation for senior equity and fixed-income traders has fallen by more than half since 2007, according to Options Group, a New York executive search firm specializing in the financial industry.
“The days when you could get a 30 percent to 50 percent jump in salary guaranteed for two years and a 20 percent to 100 percent signing bonus are gone,” says Options Group CEO Mike Karp. “And they are never coming back.”
The pain for some has created opportunities for others. The bond market’s next chapter is taking shape in a 106-year-old brick building in lower Manhattan that used to store fountain pens. These days it houses startups. Amar Kuchinad, founder and CEO of one of them, Electronifie Inc., is building a digital trading platform for corporate debt.
Sitting in a conference room in the firm’s loft-style office, complete with Ping-Pong table, Kuchinad describes how he became intrigued by the changes wrought by Dodd-Frank and the Basel Committee on Banking Supervision. So he quit his job as a managing director in Goldman Sachs’s credit-trading unit in 2011 and joined the Securities and Exchange Commission as a senior policy adviser. Suddenly, he found himself on the other side of the table from his former industry as it dealt with new capital ratios.
“I saw market participants come to Washington and tell the agency, ‘This is going to crush liquidity in the corporate bond market,’” Kuchinad says.
He drew another conclusion: The time had come to provide a digital alternative that could match buyers and sellers without the need for dealers. In 2013, he formed Electronifie, and since then it has executed about $2 billion of transactions with a network of more than 450 traders. It’s not alone. Dozens of platforms, including industry leader MarketAxess Inc. and one owned by Bloomberg LP, the parent of Bloomberg News, are making inroads with the model.
“That means a lot more of this business is going to be data-driven instead of relationship-driven,” says Kuchinad, 42.
Investors, too, are seeing their models shaken by the stark realities of a post-crash world. Pension plans and the super-rich plowed cash into hedge funds, whose combination of mystique and exclusivity promised market-beating performance. As assets in these vehicles almost doubled to $2.7 trillion from 2008 to 2015, they’ve delivered anything but. The S&P 500 Index returned 80 percent including reinvested dividends in the five years through July 20 compared with a decline of 1.3 percent for the HFRX Global Hedge Fund Index.
Adding insult to injury, investors typically pay hedge funds a 2 percent management fee and 20 percent of their profits. You can buy shares in an S&P 500 ETF for 0.09 percent. More than 970 hedge funds closed last year, the most since 2009, according to Chicago-based Hedge Fund Research. Tudor Investment Corp., the $11.6 billion hedge fund run by Paul Tudor Jones, said in May that it would reduce its fees. Mutual funds are getting hit, too. On June 16, Grantham Mayo Van Otterloo & Co., the Boston firm founded by Jeremy Grantham, cut 10 percent of its 650-person staff following a 20 percent drop in assets.
It’s no wonder the best and brightest are casting their eye on careers in Silicon Valley instead of Wall Street. At New York University’s Stern School of Business, students are seeking out courses that blend finance, technology and entrepreneurship.
“They want data analytics first and foremost, and they’re much less interested in the pricing of derivatives,” says David Yermack, chairman of the school’s finance department. “Corporate finance as we have taught it is less and less relevant. In a way, we’re at the same risk of disruption as the banks.”
Some industry stalwarts see little choice but to disrupt themselves. For 30 years, the brokers at Icap Plc have traded swaps, U.S. government bonds and other securities for dealers worldwide. On a June afternoon, you can see a vestige of their operation at Icap’s base near London’s Liverpool Street Station. A trader on the interest rates swaps desk jumps up and hollers a bid as he slaps a phone receiver into his palm. Others shout counteroffers, while a pair of apprentices with Sharpies jot numbers on a tote board.
Zoom out, though, and you’ll see some of the surrounding desks are unoccupied. This can’t be chalked up just to electronification. With capital ratios spurring costs on risk-weighted assets and low interest rates squeezing gains, volume has slid along with the unit’s profit margins. In the fiscal year ended in March, voice-broking accounted for only one-fifth of Icap’s trading operating profit, and in November CEO Michael Spencer made a deal to sell the division to Tullet Prebon Plc for 1.1 billion pounds ($1.4 billion).
Now the interdealer broker is transforming itself from a noisy bazaar into a fintech firm organized largely around its post-trade risk and information business. Later this year, the unit will roll out an offering designed to help banks save money by replacing the outdated systems used to reconcile and validate trading positions with one simple platform.
“Banks are so stressed now,” says Jenny Knott, CEO of post-trade risk at Icap. “Surviving with the current margins isn’t going to be achievable, and regulation is still coming. These guys have to take out costs over the next years. They have to turn stuff off as quickly as possible.”
For all the tumult, some senior bankers are confident their industry will eventually emerge stronger and leaner.
“Imagine what happens when the foot comes off the brake and clients start trading more actively and interest rates start rising,” says Chris Purves, the London-based global co-head of fixed-income rates and credit trading at UBS Group AG, which has scaled back fixed income to concentrate on wealth management. “You’re going to have these battle-hardened, tremendously efficient operations that can scale quickly.”
It’s an optimistic thought. But the big question for the rest of society is whether the financial-services industry will indelibly change its ways. Throughout its history, Wall Street has profited from complexity. During the housing boom in the 2000s, it wrapped relatively simple instruments like mortgages in complicated schemes ostensibly designed to neutralize risk. Economies in Europe and the U.S. continue to endure the reverberations of that frenzy of CDOs and CMOs and CDSs and CDOs squared.
Lawmakers on both sides of the Atlantic are betting that by forcing banks to shun leverage and take on more capital they can break the industry’s dangerous habits, once and for all. There’s a lot riding on the fulfillment of those goals. In the U.S., anger over bank bailouts fueled populist movements ranging from Occupy Wall Street and the Tea Party to the campaigns of Bernie Sanders and Donald Trump. In Europe, the events of 2008 exposed the fiscal weaknesses of the 28-nation EU and ushered in a period of austerity and popular revolt that appears to be intensifying.
Even with all the changes, four of the six biggest banks in the U.S. are larger than they were in 2008. In Britain, the assets of the top four banks are more than twice the size of the nation’s economy.
“The industry is less complex than it was, it does have less leverage, and it is tamer,” says Sallie Krawcheck, president of Bank of America’s global wealth-management division from 2009 to 2011 and now head of Ellevest, a digital-investment platform for women. “But is that enough? If a similar crisis were to happen again, would any of these institutions remain standing? I would guess the answer is no.”
-- With assistance from Dakin Campbell, Yalman Onaran, Donal Griffin, Laura J. Keller, Gavin Finch and Saijel Kishan.