The End Of History
November 12th, 2008 by 
reality
Michael Lewis, author of Liar’s Poker, accurately and devastatingly recounts the history of mortgage securitization and Wall Street. He correctly identifies the cause of the meltdown of the investment banks, that is, their conversion from partnerships to public companies:
From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.
No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.
Posted in Fixed Income, Rogues and Rascals, Stocks | 
November 12th, 2008 at 9:03 am
Right on the money. Worse yet was that IB’s like Salomon, once merged with a commercial bank (recall the provision of Glass-Steagall eliminated to allow Sandy to combine Citi with Travelers/Salomon)suddenly had access to seemingly unlimited bank capital that included the Federally guarnteed deposits from all of us. With that kind of capital base, and only upside (bonuses) and no downside (”yes we are taking losses, but we still have to pay the bonuses or we will lose our key people…) a firestorm of speculation ensued. I should know, I was an MD in Citi’s Corp/IB. So how do we seek to fix the problem: allow all of the IBs (except Lehman)to merge with, or become, banks! Kill the cancer by smoking more cigarettes? If we now give Tax Payer money to these same people with the same institutional culture, what do we think will happen? Is it any surprise that they want to use the money to pay bonuses? Also, the terribly corroded credit/risk groups in these institutions, who are now triumphantly shouting that “we told you so”, are very unlikely to resume lending on any kind of balanced risk/reward basis. End result, we give money to these institutions, it is used to pay bonuses, take some write-offs, and no one lends because we have to “preserve capital” and “wait and see”. This is not going to fix the problem.
November 12th, 2008 at 9:40 am
No, it isn’t. However, it is not only the investment banks where the private interests of the employees, particularly the executives, have been allowed to supersede those of the shareholders. Executive compensation and employee stock options have provided similarly perverse incentives almost everywhere.