Frank Partnoy: Facebook Has Summer Interns Who Could Close More Mergers Than You

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Frank “F.I.A.S.C.O.” Partnoy has a column in today’s FT pointing out that you'll probably be replaced by an iPhone app pretty soon:

In the future, improved technology will reduce the number of human beings needed to allocate capital, as it has done in other service industries. People will also play a smaller role in dealmaking and trading, just as they do when we board a plane or shop for clothes. HSBC is downsizing so dramatically because its leaders look at technology companies and see their bank as a dinosaur that must shed weight or become extinct. …

Facebook and its peers also play an allocative function, just as banks do, except they help people move content instead of capital. Social network firms and banks both allocate information; in one case it is personal data and in the other it is money. As with Google, though, the employment numbers differ starkly. Facebook’s equity is worth more than that of most banks, yet it has just 2,000 employees.

Imagine the following thought experiment. If all of the world’s major banks had failed during 2007-08, and regulators had permitted Apple, Facebook, Google and Microsoft to take over the economy’s capital allocation function, how would employment numbers have changed? Surely any neo-bank would hire smart lenders, traders, analysts and advisers, the people who have the strongest relationships with, and knowledge of, the institutions that demand or supply capital. But would they have hired all of them? Half? How many people would a new bank really need? Hedge funds take on traditional bank functions with a fraction of the employees.

And sometimes that doesn’t work out!

It’s kind of hard to argue with a lot of what Partnoy is saying. The financial industry is big on path-dependency, and a lot of what big banks do would probably not have been your first choice if you were designing yourself an ideal financial system. Reuters today has an article about bankers complaining about low fees from equity sales by U.S. government-owned companies and, as a former capital markets banker, I’m all for fee discipline but come on:

At 0.75 percent, underwriters earned $136 million in fees from the common stock portion of GM's IPO. Out of these proceeds, banks pay attorneys and internal staff, as well as roughly half of investor roadshow expenses such as hotels, meals and jets. … "The GM IPO at 75 basis points was essentially uneconomic for the firms that spent all the time doing it, given how many man-hours went into it," the banker said.

Er, right. If you really can’t figure out a way to sell shares of an iconic American company while spending less than $136 million on private jets, maybe you do need to take another look at your cost structure.*

Still it’s not entirely fair to ask what Google would do if it were reinventing the capital allocation process from scratch (though, yes, it would involve fewer bankers). Actual Google and Facebook, as opposed to imaginary Google Sachs and Bank of Facebook, make the bulk of their money on basically unregulated online advertising. Banks don't have that luxury. Jamie Dimon will be happy to tell you about how regulation and capital requirements add to banks’ costs. If you don’t believe him, ask his friends at Main Street Bank of Kingwood, Texas, for whom the Journal yesterday shed a tear because they’re packing up shop and becoming a non-FDIC financial company rather than deal with FDIC capital regulation. That is unlikely to happen to LinkedIn.

The costs of being in a regulated, “systemically important” industry probably explain a lot of why banks do less with more people than high-tech companies. It also may explain why hedge funds can do bank functions with fewer employees. That’s not necessarily a good thing - a couple of fascinating and important recent papers (by Zoltan Pozsar at the IMF, via Marginal Revolution, and by Morgan Ricks at Harvard Law School) delve into the explanations for why non-bank entities have taken over traditional bank money creation functions, and remind us that they arguably pose more systemic risks than banks with less regulatory oversight.

It’s probably a good thing that banks whose mistakes can bring down our entire economy get more regulatory attention than the companies that are re-configuring our souls. We didn't need those anyway. But as long as that extra scrutiny is there, banks may continue to be less efficient than, y'know, the most efficient companies in history. Which may be good for your job security. Especially if you're checking Facebook all day when you're supposed to be pitching mergers.

* Yes I realize that that $136 million was split among approximately 236 million banks (http://www.sec.gov/Archives/edgar/data/1467858/000119312510262471/ds1a.htm) but still – that’s an inefficiency too.

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