William Cohan, one of America’s most respected financial journalists, has written an excellent, well-balanced book about Wall Street. Cohan argues that, despite the flagrant misbehavior by some Wall Street firms that led to the 2008 Recession, we have the finest financial industry in the world.
He says defining Wall Street is difficult. Is Wall Street just a handful of major money-market banks that were the primary culprits? Or is Wall Street the 7,000 medium and smaller banks, 14,553 hedge funds and thousands of asset managers?
Regardless of how you define it, the entire world has profited enormously from our banks’ activities.
Wall Street:
1. Moves capital from savers to borrowers.
2. Lends us money to buy a home and cars and makes it possible to make credit card purchases.
3. Offers asset-management advice and services to institutions and individuals.
4. Underwrites new equity and fixed-income offerings to governments and corporations.
Cohan criticizes politicians who advocate breaking up the big banks without making specific recommendations. Cohan believes reducing the role and/or scope of banks would jeopardize our financial system.
Cohan worries that the new regulations imposed after 2008 have included such tight rules that the banks cannot provide capital to those who need it.
Federal Reserve Chairwoman Janet Yellen disagrees. At the recent Jackson Hole summit, she said that a “growing body of research shows that the core reforms we have put in place have substantially boosted resilience without unduly limiting credit availability or economic growth.” She said regulations could be rolled back on small banks that were not major contributors to the 2008 global financial crisis.
Cohan disagrees with the so-called “living wills” mandated by the 2010 Dodd-Frank Act. This requires the eight systematically important banks to submit to the Federal Reserve each year how their operations would be wound down in the unlikely event of a bankruptcy. Cohan points out that these banks are complicated organizations and asks whether federal regulators can properly evaluate all of the imponderables that could cause a bankruptcy.
Cohan feels that, under Dodd-Frank, we have forced banks to increase their regulatory staffs unnecessarily and given the regulators too much authority. They can review all trading decisions and lending practices and even attend board meetings.
Cohan proposes solutions to avoid the abuses that led to the Great Recession. He would impose criminal and civil sanctions on any Wall Street executive found guilty and favors clawing back 100 percent of their ill-gotten gains.
Cohan believes that Wall Street innovations have “democratized” capitalism with innovations that help millions of people get financing more cheaply.
I had a personal role in one such innovation. I created a security, called the inverse floater, in 1984. This innovation has enjoyed much success, especially for investors who want a higher income than offered by money market funds but who want a security with a short maturity. The inverse floater’s income rises when interest rates decline and it has been an excellent vehicle.
As an example of how Wall Street products continue to evolve, since I created this security, other financial engineers have made improvements. Examples: This security has been used both in the taxable and tax-exempt markets and almost every mortgage-backed security has an inverse-floater tranche.
I also can attest to the truth of Cohan’s argument that the three most dangerous words are “other peoples’ money.”
I became a partner of Morgan Stanley in 1984 when it was a private investment bank. Because we had personal liability, we took prudent risks to earn our bonuses. Once we went public in 1986, however, the firm’s employees began to take enormous capital risks to enhance their bonuses.
The risk-taking led in the short-term to doubling or tripling their income. But, ultimately, the company had to pay the piper.
In 2008, Morgan Stanley had to borrow $107 billion to remain solvent.
Originally published in the Sarasota Herald-Tribune
