Wall Street Makes Even More This Year!
Wall Street bonuses will set a new record. Total compensation and benefits for 2010 will hit $144 billion - $5 billion more than last year's record $139 billion.
Hey, I thought we were in a recession!
Of course, the recession officially ended in June 2009. But that's not why compensation is up. After all, even with the recession lasting through about half of 2009, record bonuses were paid out. So how is all this possible?
Well, one obvious reason could be that after the collapse of both Bear Sterns and Lehman, the investment banks that survived picked up the slack. They got more business. Essentially, with the demise of two of the biggest investment banks, there was less competition. So fewer banks got to slice up the pie.
But wait. Doesn't common sense tell us that in a recession there would be less overall business?
Well, common sense would tell us that. But, of course, such economic "laws" as supply and demand only tell part of the story of how Wall Street banks make money. The fact is investment banks make lots of their money trading. They do other things, but more and more of their profits have come from their trading operations. It's something that's been going on for years, and it hasn't slowed down with the financial crisis.
I'm not sure when trading activity began to become a dominant factor in investment banking. But if you read a book like Michael Lewis's classic Liar's Poker you'll see that trading was a big part of the action back in the 1980's. (By the way, it's a fun read and really does give you a good sense of what Wall Street's all about.)
Of course, the rise in the importance of trading to Wall Street banks' profits meant that, more and more, banks found themselves confronted with issues of conflict of interest with their clients. A good example of this would be Goldman Sachs selling products to clients that profited when real estate values increased, then going out and betting against real estate going up.
Of course, Goldman claimed that they were just being prudent - just "hedging their book," as they say in the business. That's somewhat true. On the other hand, when investigators dug deeper, they found that Goldman went far beyond hedging. They bet against their customers. They bet against their customers' success. They put their own success above the interests of their customers. (How many ways can I say it?)
And let's not forget the fact Wall Street compensation exploded with the increasing success of the banks' trading departments. The traders, of course, make most of that money. But the increased profits of the institutions meant everyone made out better in the end.
So the trading operations weren't slowed any by the recession. In fact, they're success was enhanced. With the record low interest rates we've seen for the last few years - and no chance those rates will go up anytime soon - they're assured of a source of cheap money that they can use to make trading profits.
It's called the "carry trade" and it means the banks borrow at a low interest rate and invest in something that gives them a higher rate. For example, they borrow at 1 % (it's actually less than that) and buy treasuries at 3.5%. They make a guaranteed 2.5%.
Now that doesn't sound like much - and it isn't. But they don't top there. They "leverage" the trade. That is, they borrow even more money. They'll leverage the trade up four, five, even more times. They'll make 10% or more - guaranteed. (Treasuries pay a guaranteed rate of return of both interest and principal.)
They'll do this over and over until they can't do it anymore (like if interest rates change and they can't borrow as cheaply).
Meanwhile, with interest rates so low, you and I get nothing for our "safe" money - you know, stuff like CD's, money markets, etc. That stuff's paying a paltry - what? - 1%, probably less. And it's really bad for folks on a fixed income, like seniors who need the income just to eat and pay the rent.
Of course, the trading desks do other types of trades. But the point is when you can get this guaranteed money doing this simple trade, you've got a nice flow of cash coming in to either stick in your pocket, or spend on riskier trades that make even more money.
Unless, that is, you can't borrow all that money to leverage your trades. Which was, by the way, one of the items I've been saying really does need reforming - when all the talk about new regulation started last year. But no worries there.
You see, all that financial regulatory reform we've read about really didn't address this idea of banks leveraging. Like I said, I (and others) had identified the leveraging issue as one of the immediate causes of the dramatic and catastrophic collapse in 2007 - 2008. And I suppose I kind of thought that if regulation was going to be "reformed" that leverage - being one of the main causes of all the problems - would be regulated more strictly. But what do I know?
So, not to worry guys. Your bonuses are safe for this year and the foreseeable future. And, speaking of safe, my money in CD's and money markets is safer than ever. Of course, it's not earning very much. Aw, stop complaining. I should have just gotten a job as a Wall Street banker, right?
Hey, I thought we were in a recession!
Of course, the recession officially ended in June 2009. But that's not why compensation is up. After all, even with the recession lasting through about half of 2009, record bonuses were paid out. So how is all this possible?
Well, one obvious reason could be that after the collapse of both Bear Sterns and Lehman, the investment banks that survived picked up the slack. They got more business. Essentially, with the demise of two of the biggest investment banks, there was less competition. So fewer banks got to slice up the pie.
But wait. Doesn't common sense tell us that in a recession there would be less overall business?
Well, common sense would tell us that. But, of course, such economic "laws" as supply and demand only tell part of the story of how Wall Street banks make money. The fact is investment banks make lots of their money trading. They do other things, but more and more of their profits have come from their trading operations. It's something that's been going on for years, and it hasn't slowed down with the financial crisis.
I'm not sure when trading activity began to become a dominant factor in investment banking. But if you read a book like Michael Lewis's classic Liar's Poker you'll see that trading was a big part of the action back in the 1980's. (By the way, it's a fun read and really does give you a good sense of what Wall Street's all about.)
Of course, the rise in the importance of trading to Wall Street banks' profits meant that, more and more, banks found themselves confronted with issues of conflict of interest with their clients. A good example of this would be Goldman Sachs selling products to clients that profited when real estate values increased, then going out and betting against real estate going up.
Of course, Goldman claimed that they were just being prudent - just "hedging their book," as they say in the business. That's somewhat true. On the other hand, when investigators dug deeper, they found that Goldman went far beyond hedging. They bet against their customers. They bet against their customers' success. They put their own success above the interests of their customers. (How many ways can I say it?)
And let's not forget the fact Wall Street compensation exploded with the increasing success of the banks' trading departments. The traders, of course, make most of that money. But the increased profits of the institutions meant everyone made out better in the end.
So the trading operations weren't slowed any by the recession. In fact, they're success was enhanced. With the record low interest rates we've seen for the last few years - and no chance those rates will go up anytime soon - they're assured of a source of cheap money that they can use to make trading profits.
It's called the "carry trade" and it means the banks borrow at a low interest rate and invest in something that gives them a higher rate. For example, they borrow at 1 % (it's actually less than that) and buy treasuries at 3.5%. They make a guaranteed 2.5%.
Now that doesn't sound like much - and it isn't. But they don't top there. They "leverage" the trade. That is, they borrow even more money. They'll leverage the trade up four, five, even more times. They'll make 10% or more - guaranteed. (Treasuries pay a guaranteed rate of return of both interest and principal.)
They'll do this over and over until they can't do it anymore (like if interest rates change and they can't borrow as cheaply).
Meanwhile, with interest rates so low, you and I get nothing for our "safe" money - you know, stuff like CD's, money markets, etc. That stuff's paying a paltry - what? - 1%, probably less. And it's really bad for folks on a fixed income, like seniors who need the income just to eat and pay the rent.
Of course, the trading desks do other types of trades. But the point is when you can get this guaranteed money doing this simple trade, you've got a nice flow of cash coming in to either stick in your pocket, or spend on riskier trades that make even more money.
Unless, that is, you can't borrow all that money to leverage your trades. Which was, by the way, one of the items I've been saying really does need reforming - when all the talk about new regulation started last year. But no worries there.
You see, all that financial regulatory reform we've read about really didn't address this idea of banks leveraging. Like I said, I (and others) had identified the leveraging issue as one of the immediate causes of the dramatic and catastrophic collapse in 2007 - 2008. And I suppose I kind of thought that if regulation was going to be "reformed" that leverage - being one of the main causes of all the problems - would be regulated more strictly. But what do I know?
So, not to worry guys. Your bonuses are safe for this year and the foreseeable future. And, speaking of safe, my money in CD's and money markets is safer than ever. Of course, it's not earning very much. Aw, stop complaining. I should have just gotten a job as a Wall Street banker, right?
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