Running Down Wall Street

Author:
Publish date:
Updated on

Bear Stearns. Lehman Brothers. Merrill Lynch. Three of Wall Street's venerable names failed to persuade the markets that they would survive as independent banks. Yesterday the last two of the independent titans of Wall Street came under fire.
Both Goldman Sachs and Morgan Stanley are were battered yesterday by the stock market. At its lowest point, Goldman was down 25 percent, with its stock trading below $100. Morgan Stanley was hit even harder, plunging 40 percent in intraday trading. By the end of the day, the question was which commercial bank would combine with Morgan Stanley, and whether Goldman might go private or also merge with a commercial bank.
Behind the scenes things were even worse. Hedge fund clients were in full flight from Morgan Stanley and Goldman Sachs, according to a person familiar with the matter. The larger commercial banks found themselves inundated with new clients for their prime brokerages. As many as twenty hedge funds approached one large commercial bank with a prime brokerage. It looked like a run on the banks might get started.
The process of watching an investment bank rapidly implode can be perplexing. Why should even a dramatic decline in its stock price force an investment bank out of business? Even if investors lost confidence in the investment bank, wouldn't it still have a strong team in place that could continue serving its customers? As with Bear Stearns, Lehman and Merrill Lynch, however, the customers of Morgan Stanley and Goldman Sachs apparently began to pull their business while the share price faltered, according to our source. It looked as if the stage was being set for another run on the bank.
Scholars looking at the old-fashioned bank runs of the 1930s, when customers raced to withdraw their deposits from faltering banks, have come up with an explanation for bank runs that sheds light on what happened to Lehman Brothers last week. As it turns out, shareholders unknowingly provide an important service for a bank's customers, providing outside oversight of a bank's activities. In particular, scrutiny by sophisticated institutional shareholders can act as a check against abusive or overly risky activity. A sell-off by these shareholders signals two things: risk at the bank has increased and the shareholder oversight mechanism is no longer in place.
The customers of investment banks, like depositors at commercial banks, depend on shareholder scrutiny, and withdraw their business from the banks when a dropping stock price signals this has broken down. Yesterday, enough shares traded hands to replace nearly every third owner of Goldman Sachs and Merrill Lynch. It hadn't reached the Lehman stage yet, where the volume over a few days amounted to every share of the companies stock. Still, customers watching could conclude that the shareholders who had been watching the shop had fled for the exits.
Until last week, many believed that Lehman couldn't fall prey to a Bear Stearns style bank run because it had something Bear never had: access to the primary dealer lending facility, a special program that allows investment banks to borrow from the Federal Reserve's emergency discount window. Opened after the collapse of Bear, the discount window should have guaranteed Lehman wouldn't ever lack the funds it needed to run its business. But according to people familiar with the matter, Lehman's customers last week started moving their funds from margin accounts, which Lehman could tap for liquidity, to segmented custodial accounts, where the money is out of Lehman's reach. As the process played out, Lehman would quickly find itself grasping for funds. If customers and investors don't regain confidence in Morgan and Goldman, the same process could well get underway.
Just as banks' depositors occasionally make runs on banks despite the existence of deposit insurance, investment banking customers of Lehman began a bank run despite the emergency backstop. They may be preparing to do the same to Goldman and Morgan. In the end, the Fed's backstop is no substitute for trust and scrutiny by the markets.

Related

News

How Can Wall Street Feel Alive Again?

As some of you may recall, there was a time not too long ago when you could work on Wall Street and be compensated in a way that made you feel special. Appreciated. Loved. Eight, nine, ten-figures of love. Now, obviously, not so much. But that is not what's eating the industry's most fragile spirits of late. They are fine taking pay cuts. They could care less about the money. What they're not fine with is having the rush, the intensity, the adrenaline-pumping fear that comes with, say, putting on a trade in which maybe the firm will make $1 billion or maybe it'll lose $10 billion, WHO KNOWS, IT'S ALL RELATIVE, I CAN'T FEEL MY LEGS, THAT'S WHAT MAKES IT SO EXCITING taken away from them. Take Sean George. He used to spend his days destroying company property and now, thanks to financial regulation, has had to get his kicks elsewhere. Sean George kneeled in the Church of St. Paul the Apostle in Manhattan. He wasn’t praying. A gash below his right brow bled into his eye and down his nose before a knee to his groin sent him to the floor. George, 39, head of credit-derivatives trading at Jefferies, was making his Muay Thai debut at the church June 22 in a sport that allows kicking, elbowing and kneeing. His eye was swelling shut by the time he lost in a split decision. It was the happiest he’s been all year, he said. “Right now at work I’m making less risk decisions -- and I enjoy taking risks,” George, who headed investment-grade credit-default-swap trading at Deutsche Bank AG before he joined Jefferies last year, said in an interview. “If you’re in it for the game and the fight, the game’s over and the fight’s over.” Risk is what drew George and the colleagues he respects to Wall Street, he said. He could bring in millions of dollars in a single month at his peak, and trading was so intense that during one credit-default-swap deal he smashed a phone against his desk, sending part of it three rows away, “one of the records for the best break,” he said. Ethan Garber's lost that tingly feeling in his plums. “There’s no sexiness, there’s no fun, there’s no intellectual intrigue, either,” said Ethan Garber, who ran proprietary credit-arbitrage portfolios for Credit Suisse Group AG and Bear Stearns Cos. “A lot of my friends who actually lingered for the last four years are all now getting fired anyway,” said Garber, 45, currently CEO of IdleAir, a Knoxville, Tennessee-based firm that provides electricity at truck stops. “The air is taken out.” Robert McTamaney has been reduced to doing his best impression of a whiskey-swilling, cigar-chomping newspaper man from the 1940's, who we assume addressed Bloomberg's Max Abelson as "toots" here. “The socks are higher, the skirts are longer,” said McTamaney, who helped run Goldman Sachs’s equities- trading business in Asia. “It’s like styles: They change, and you’ve got to change with it or be left behind.” Former King Street Capital and Bank of America trader Sam Polk isn't gonna lie, the worst part of Wall Street 2.0 is not being able to feel like a god by dropping $10,000 for bottle service on Wednesday nights, and sometimes even Thursdays. “You could be a 20-something trader three years out of school, able to go to any restaurant or club or ballgame on any night that you wanted, and it was totally paid for,” he said. “It was a tremendous feeling of power.” Michael Meyer is dying a slow, painful death. “The light at the end of the tunnel is dim,” said Meyer, now co-head of sales and trading at New York investment bank Seaport Group. Clearly, it's not pretty. But here at Dealbreaker we're about offering solutions, not whining about problems. How can these guys and girls replicate the feelings they once got by taking on risk on the job, if, unlike Sean George, getting kicked in the balls is not their thing? Drinking the carton of milk in the break room that's been sitting out for two days, telling the boss's wife it looks like she's gained a couple pounds, having unprotected sex with a junkie, shouting "You go girl!" at yourself in spin class after being kindly told to "Shut the fuck up" or else, and leaving dirty dishes in the sink all seem like good jumping off points but we can do better. These people need our help. Bloodied Trader Pines For Risk As Wall Street Retreats [Bloomberg]