Edward: "You know what I used to like as a kid, Phil? Erector sets.
Phillip: So, I used to like Monopoly, Boardwalk and Park Place, what's the point?
Edward: We don't make anything, Phil.
Phillip: We make money, Edward" -- from "Pretty Woman", in which Edward bought companies and sold them off piecemeal for huge profits.
"Nothing so conveys the illusion of intelligence as personal association with large sums of money" -- John Kenneth Galbraith.
"It was so cold this morning that I saw two investment bankers walking down the street with their hands in their own pockets" -- Yours truly, trying a little humor in my talk to a financial conference, the audience was noticeably uncomfortable, but not amused.
At the most recent World Economic Summit in Davos (Switzerland), Edward Luttner, Chairman of Cantor-Fitzgerald, a major Wall Street bond-trader, complained aloud that if new regulations were enacted, "banking would become boring". When he said that, I realized instantly that he had just set the proper yardstick for judging the adequacy of prospective new regulations.
Banking should be boring for the very same reason that driving on I-5 or down Main Street should be boring. They are not the Indianapolis 500 where the point is to demonstrate the superior machine, the superior team on a course engineered to maximize speed at the expense of lots of wreckage. Driving down Main Street or I-5 is a means to an end, to pick up some groceries or to visit grandma, and the benefits to a few drivers of shaving minutes or seconds off of a route designed for high-speed is not worth the wreckage to everyone else.
That is what banking should be. Banking is not an end itself, it greases the skids. It is a means to enable companies to innovate, to expand, to try new markets, and then, simply, to pay off the credit the banks provide through ongoing operations. The banks earn money for interest that reflects the risk of non-repayment.
As the "money-congealers" of the economy, banks have the capacity to engage in a wide variety of enterprises, in many different ways. That cannot help but be very tempting. The Glass-Steagall Act was enacted during the Great Depression so that banks could not yield unto that temptation.
It took about 60 years for the memories of the Great Depression, a crisis also exacerbated by ultra-leveraging, to fade sufficiently so that a new arrogance of ideology fed in part by the power of personal computing provided policymakers comfort that sophisticated mathematics was more powerful than basic human nature.
Nothing, John Kenneth Galbraith had told us, so conveys the illusion of intelligence as personal association with large sums of money. Galbraith, the author of The Great Crash, 1929, should have been heeded.
When most people look into their mirrors in the morning, they see themselves, for better or worse. When bankers--or, more generally, Financial Executives--gaze into their mirrors, they see Brad Pitt or Angelina Jolie staring back at them.
The high-flying part of finance is investment banking. Several decades ago entry into this world was largely limited to the privileged, enabling them to use family connections (and country club memberships) to extend their wealth without working overly hard. They called one another by childhood nicknames, a holdover from their days at Eastern prep schools, where most of them had gone. [The Bush family is among this ilk].
In those days these guardians of the magic kingdom of easy wealth, had something to sell--access to capital or, more accurately, access to the people who had the capital. In exchange for such access, clients paid a commission on the amount of capital they mobilized because there were no alternatives.
As the markets matured, and capital became more widely available, and as others without the right family connections and surnames were admitted to the temple, investment bankers no longer controlled access to capital through their connections. The rationale, therefore, for a commission-based compensation disappeared. Nonetheless, grandfathered, it continued without challenge. And, as the size of deals ballooned as the economies grew, so did their commissions.
And, although it is true that the larger deals had somewhat more complexity, a $10B deal is not 10-fold more challenging than a $1B transaction. Moreover, the guardianship of the gates was now more of an imprimatur of legitimacy, and a spreading of risk, than it was a true barrier.
If one listens to the sycophants of the financial world on CNBC, one would think that the enormous commissions made somehow equates with "productivity", but in fact there is little correlation of these incomes with the production of anything except the commissions.
One way to be certain of this is that if a deal, or a financing, were done without the investment bankers' commissions, there would be nothing lost. By complete and utter contrast, for example, consider Bill Gates's contributions to strategy and product offerings from Microsoft. Several software companies preceded Microsoft, and could have capitalized on their initial successes; they did not, so that absent Gates's vision and skills much that we now take for granted, such as the program used for writing this article, would have not have been developed and widely marketed, at least for a significant period of time.
This is not to suggest that the investment bankers have nothing to offer, or that spurts of all-nighters are not sometimes required. The banks engage in the diligence required to determine that a deal is worthy, although the standards were stretched--after all, if a big payday were in store if the diligence came out positive vs. nothing if it were negative because no deal would done, there is a natural bias in favor of deal-worthiness.. The banks also round up the pools of cash to make deals work, and they can play bad-cop in negotiations with the parties.
But the observation that the bankers provided some benefit, and should certainly be paid for it, is not the same as justifying the enormous salaries and bonuses they received by continuing the old practice of charging a percentage of the deal, or the repeated statements by the financial press that these are some of the nation's most productive people--they are not.
Indeed, a major objection to a more rational and regulated financial system is that "the best minds will not go into banking". Agreed. Would we not be better served if the best minds went into true value-enhancing endeavors such as engineering, or medical science, or, heaven forbid, teaching.
Finally, as we have painfully learned, banking touches all of our lives. If the bankers want their fun and games, they ought not to be allowed to do it with our hard-earned money. Part of the arrogance is the assumption that everyone is, or has the reserve capacity to be, a risk-taker.
Make banking boring. Again. We will all be better off.