Jim Irsay, LA Times, October 16, 2013Does anyone really think that Irsay wouldn’t love to have Peyton Manning back from the undefeated Denver Broncos and with the Colts? After all, they were 2-14 in 2011, while Manning took Denver to the AFC Championship game in 2012.Recently, financial services has sounded a bit like football, some victory speeches, but a lot of sour grapes and recriminations. One of the bigger recent bombshells was Sandy Weill’s 180 last July in which he declared that we should go back to the days of Glass-Steagall, that the big banks should be broken up, and that all financial instruments should be marked-to-market.
There’s something a bit jarring about so much politically correct penitence, but it’s always a good idea to ask what one of the most successful dealmakers of the last hundred years is really thinking. At one point, there were rumors that Weill would retake the reins at Citi to clean up the mess, but … no takers. Then again, following a little public penance and an act of contrition or two, who knows? A break up could be just the ticket for getting back into the game. The real question is which version of Sandy Weill is right.
Mayday, May 1, 1975, isn’t so long ago. That’s when ‘deregulation’ of brokerage commissions went into effect. People often call it a deregulation, but what really happened was that the government put a stop to 183 years of price fixing that had kept the margins and bottom lines of brokerages fat. As a fungible commodity, the trading of financial assets was always susceptible to a race to the bottom. Meanwhile, on the banking side of the house, the creation of money market funds squeezed bank margins, too.
Looking back from 1997, financial innovation had crushed margins at both banking and brokerage, and a wave of consolidation and restructuring was already well underway. Also, the proliferation of mutual funds had eroded margins in asset management by as much as 75%. The only bright spots at the time were investment banking and providing shelf space for third-party asset managers. Looking forward from 1997, it’s fair to ask Sandy Weill the obvious question: What was your alternative? The equally obvious answer was diversification and cost cutting, hence consolidation of operations and the spin-off of unprofitable business units.
By contrast with Sandy Weill, William Harrison Jr., who retired as CEO of JP Morgan in 2006 wrote an op-ed defense of the banks for the New York Times in August 2012 that: “The anger [at the banks], while understandable, has fueled the misguided idea that we should break up the nation’s largest banks.” Like the banks, the truth is often unpopular. By permitting greater diversification at the major wirehouses, the repeal of Glass-Steagall likely decreased the impact of the financial crisis. In that regard, it’s important to remember that Lehman and Bear-Stearns, the failures that triggered the crisis, were the least well diversified of the major players. Richard Kovacevich, who retired from Wells Fargo in 2010, also disputed the claim that the banks should be forced to divest their diversified lines of business.
Sandy Weill’s second point about marking to market, was if anything, even less cogent. The illiquidity of many securitized assets makes a rigid mark to market rule impractical, if not impossible. In any event, the evidence points strongly the other way. Mark-to-market paralyzed trading and made the crisis worse.
As the architect of the universal wirehouse, there’s no question that Sandy Weill understood the pressure on margins that led to consolidation. Likewise, under the voluntary rule, Citi made a deliberate decision not to mark to market because of the effect market volatility would have on capital. Following the passage of Sarbanes-Oxley (SOX) in 2002, it’s just not credible that he didn’t know it.
Keeping in mind that there was nowhere to hide from market forces, some of Wall Street’s corporate officers knew the basic situation. Traditional banking and brokerage are no longer the pillars they once were. Today they are feeder components of a more diversified pot that provides capital financing for corporate and housing development on scales far beyond the reach of either. Recriminations aside, by 2007 the financial services industry was where it was because there was nowhere else to go.
Author: James Beck PhD