Why Wall Street Matters

William D. Cohan “Why Wall Street Matters,”  Random House, 2017, 147 pp.

This book attempts to prove to the reader why Americans should want Wall Street to exist and to succeed.  It is also meant to serve as a starting point for a long-overdue, nonhysterical (think Elizabeth Warren or Bernie Sanders) national debate about how to retain the best of Wall Street while dramatically modifying the compensation incentives that tend to foster the basest instincts of human nature we have seen multiple times since 1987.  Fix the compensation system—make bankers, traders, and executives fear for their art collections, their co-ops, and their homes in the Hamptons—and sit back and watch how quickly it works to change people’s bad behavior.

Author William D. Cohan is no knee-jerk advocate for Wall Street and the big banks. He’s one of America’s most respected financial journalists and the progressive bestselling author of House of Cards. He has long been critical of the bad behavior that plagued much of Wall Street in the years leading up to the 2008 financial crisis, and because he spent seventeen years as an investment banker on Wall Street, he is an expert on its inner workings as well.

My Notes:

Pg. xxix: Financial crisis will recur whether or not Wall Street exists.  The overarching necessity is to regulate Wall Street in such a way that preserves the things that it does right while also making sure that the people who work there have the correct incentives to not do the things that lead to financial calamities. 

Pg. 18:  What we think of as “Wall Street” no longer exists on Wall Street. To be sure, a number of important financial institutions—among them Goldman Sachs, American Express, and AIG—still have their headquarters in the vicinity.  Computers and phones have made physical interaction between traders and bankers somewhat obsolete. 

Pg. 21:  Wall Street is in the business of matching the people with capital—such as savers and investors—with the people who want and need capital to grow their businesses.

Pg. 26:  In 1933, in the wake of the Great Depression, the Federal Deposit Insurance Corporation, or FDIC, was created to protect the savings of individual depositors—the insurance now covers losses up to $250,000 per person at a single bank.  These days, in part because of the 1999 repeal of the Glass-Steagall Act, the Depression-era law that separated commercial banking from investment banking, big banks manage people’s money in order to try to increase their wealth.  They manage money for other institutions, such as endowment and pension funds.  They advise corporate CEOs on the buying and selling of companies—their own or others—or various pieces of their businesses or others’ businesses.  They underwrite stocks and bonds and trade them and make markets in individual stocks and bonds to give the market ‘liquidity.’ 

Pg. 27:  The Wells Fargo cross-selling scam that surfaced in 2016 resulted in 5,300 employees of the bank being fired for opening accounts that clients hadn’t requested in order to get fees they hadn’t earned.  (Wells Fargo is also the only instance that compensation was clawed back since 2008).

Pg. 28:  Investment banks were historically small and private, and the only capital they had available to them was the money their partners invested (a hugely important distinction from what they later became after they all started going public in 1970).  Prior to 1970, Investment banks were very careful and prudent in their investments; that all changed in 1970 when Donaldson, Lufkin & Jenrette (DLJ) defied the NYSE rules and went public.  Now, a bonus culture has replaced the partnership culture.  However, at the same time Wall Street’s following innovations has led to the ‘democratization of capital,’ the ability of more and more people to get access to capital at a fair price—whether in the form of a mortgage, an auto loan, or a credit card.  

Pg. 41:  TARP (Troubled Asset Relief Program) was the name of the $750 billion federal program designed to inject badly needed capital into Wall Street’s biggest banks at the most acute moment of the 2008 crisis.  What people forget about TARP is that the banks that received the billions of dollars in cash infusions not only paid the loans back with interest but also paid billions more to the government to extinguish the warrants, or small equity stakes that the government had taken in the banks as compensation for the loans.  (The government realized a $15.3 billion profit when reimbursed).

Pg. 56:  In 2002 Milton Friedman and Ben Bernanke blamed the Fed’s 1929 decision to make capital harder to get as one of the major causes for the depth and breadth of the Great Depression.  Bernanke, as Fed Chairman in 2008, held to this belief and it steered his responses to the crisis.

Pg. 69:  If Glass-Steagall had been reimposed before the 2008 crisis, JPMorgan Chase’s rescue of Bear Stearns and Bank of Americas’ rescue of Merrill Lynch would have been prohibited.  Just contemplate the idea of Lehman Brothers, Bear Stearns, and Merrill Lynch in bankruptcy at the same time.

Pg. 83:  After allowing Investment Banks to go public in 1970, Wall Street has been utterly transformed by the late 1980s from a series of relatively small, undercapitalized private partnerships, where the partners of the firm supplied the sparse capital needed and faced the risk of losing it every day, to a group of fast-growing publicly traded companies, where capital was relatively cheap and relatively abundant and where there was a distinct disconnect between the people who supplied the capital and the people who managed and worked at the firms. 

Pg. 88:  Lew Ranieri began packaging mortgages in 1977 (securitized mortgages) thereby spreading the risk presented by any one borrower.  The resulting securities could be sold in pieces to investors the world over, with varying rates of interest depending on an investor’s risk appetite.  Later this securitization was expanded to cover car loans and credit card bills.

Pg. 90:  Michael Milken, in the 1980s, determined that investors could make more money on a risk-adjusted basis from buying the bonds issued by companies with less-than-stellar credit ratings (Junk Bonds). 

Pg. 95:  Credit Default Swap:  In 1994 Exxon after the Valdez oil tanker debacle, approached JPMorgan for a $5 billion line of credit to cover potential liabilities related to the massive 1989 Exxon Valdez oil tanker spill.  The bank came up with the idea of off-loading the risk of the loan to a third party, in exchange for a fee, thus skirting the regulatory requirement that JPMorgan tie up capital against the risk posed by the Exxon loan.  In short order, a new industry was born: the buying and selling of risk in what became known as ‘credit default swaps,’ a form of insurance policy that allowed creditors to buy insurance against the chance that a given loan or bond would default.  (Like buying insurance on whether or not you neighbor’s house will burn down).

Pg. 103:  In September 2009 the leaders of the world’s biggest economies plus the European Union issued a communique that essentially proclaimed that they would do everything in their power to prevent the big banks from ever again causing a financial crisis (The G20 Meeting).  In July 2010 the US followed through on the G20 pledge by passing the Dodd-Frank law, which included the Volcker Rule.  (Note: Glass-Stegall was a mere thirty-seven pages long, Dodd Frank is some twenty-three hundred pages long and lawyers are still trying to figure out what it means and 20% of the regulations mandated still have not been written.)

Dodd Frank:  The Dodd-Frank Act implements changes that, among other things, affect the oversight and supervision of financial institutions, create a new agency responsible for implementing and enforcing compliance with consumer financial laws, introduce more stringent regulatory capital requirements, effect significant changes in the regulation of over the counter derivatives, reform the regulation of credit rating agencies, implement changes to corporate governance and executive compensation practices, incorporate the Volcker Rule, require registration of advisers to certain private funds, and effect significant changes in the securitization market.

Pg. 108:  It’s clear that Washington’s desire to punish Wall Street for the financial crisis has gone too far.  Instead of facilitating the recovery of Main Street, Washington’s policies have been thwarting it.  Did you know that thanks to Washington’s zealous compliance policies, the job of nearly one out of every five people working on Wall Street these days is to watch what the other four do all day long?  Even Ben Bernanke, after leaving the Federal Reserve, was turned down when he attempted to refinance his mortgage because, at the time, he was no longer employed.

Pg. 124:  Between early 2009 and the third quarter of 2014, the capital at the nation’s fifty largest banks has increased to $1.2 trillion, from $506 billion.

Pg. 132:  The days of socializing the risks and privatizing the gains, which should have come to an end after the 2008 financial crisis, have to be stopped.  In the eight years since the most acute part of the financial crisis, there has been nary a word about revamping Wall Street’s asymmetric compensation system.  Incredibly, despite the compensation system’s role in rewarding bankers traders, and executives with big bonuses for taking risks with other people’s money, they still get rewarded to take big risks with other people’s money, and there’s only a superficial effort—at best—to hold them accountable when things go wrong.  There is talk of ‘clawing back’ bonuses, but except for the recent debacle involving Wells Fargo, it has never happened.

Pg. 140:  What needs to happen—and fast—is that the leaders of the remaining big Wall Street firms need to designate the to five hundred or so top executives at their respective firms—the ones that run business lines, decide how capital gets allocated, decide who gets how much compensation and who gets promoted and who doesn’t—and along with the other members of the executive suite create a way for the bank’s creditors and shareholders to be able to go after their full net worth—everything—in the case of a meltdown, akin to what happened at Bear Stearns, Merrill Lynch, and Lehman Brothers.  This one simple change in the Wall Street compensation system would render Dodd-Frank and the Volcker Rule irrelevant.  The compliance culture could be rolled back considerably.