“From Fat Cats to Mangy Mutts”

Sydney M. Williams

Thought of the Day

“From Fat Cats to Mangy Mutts”

November 20, 2012

Are Wall Street’s glory days but a distant memory? Are we living through the new normal of finance? Michael Moore, writing in businessweek.com, predicts that 20% of financial service employees around the world won’t get year-end bonuses for fiscal 2012. It is expected that more than 200,000 global financial services jobs will be cut over the course of 2011-2012. The real number is probably higher than that, as the estimate comes from a survey that only measures the very largest global banks. In contrast, according to Bloomberg, 174,000 jobs were lost in 2009. As it pertains to the U.S., the Center for Economics and Business Research (CEBR,) a UK-based consulting firm, estimates that in four years Hong Kong will become the global center for financial employment, surpassing both New York and London. The world is changing.

Markets and the world of finance is very different from when I joined Merrill Lynch four and a half decades ago. The media constantly reminds us that we are all subject to Attention Deficit Disorder, in all aspects of our lives including investment horizons. It is no longer your grandfather’s market. In the mid 1960s, the average holding period was eight years. Today, it is five days. In one generation, we have morphed from investors to traders. High frequency trading, ETFs, and the dominance of tax-deferred retirement programs have all played a role. The first two have had the consequence of treating stocks as commodities, rather than individual companies comprised of employees, customers and communities. Retirement funds have no current tax consequences. Holding periods, therefore, are irrelevant. Corporate investor relations departments have abetted the trend, focusing on next quarter’s performance rather than strategies that may be implemented over a period of years. Institutional investors, not to be left out, demand an unrealistic level of precision from corporate managers.

From everything I read, Washington plans to use tax reform as a means of neutering investors. Returns on investments – dividends and capital gains – are expected to be taxed at ordinary income rates. Spending is what Washington does best. In a speech last week at Stanford, Dallas Federal Reserve Chairman Richard Fisher quoted “the venerable Sam Cohen – a living encyclopedia of U.S. budgetary history.” It was 1971 and federal outlays for the first time exceeded $200 billion. George Schultz was the Director of the Office of Management and Budget. Mr. Schultz asked Mr. Cohen if there was really any difference between the spending habits of Republicans and Democrats. Cohen’s reply: “Sir, there is only one difference. Democrats enjoy it more.” That has become our biggest problem. Government spends; yet, economic growth is dependent on private investment. To the extent Washington wants to increase revenues, shouldn’t they encourage investments? That simple truism seems to have escaped the wizards in Washington, as they scramble for revenue in a depleting economy.

The President campaigned for re-election on a platform of raising taxes on “millionaires and billionaires,” not unlike Franklin Roosevelt’s re-election campaign in 1936 when he campaigned against “economic royalists,” while proposing (and getting) an undistributed-profits tax. Like today, businesses in the late 1930s were hoarding cash, as confidence in the Administration’s economic policies had ebbed. Mr. Roosevelt decided that if companies wouldn’t invest their cash, it would be taxed. Seventy-five years ago that rhetoric and higher taxes had the consequence of increasing unemployment and lengthening the Depression. It didn’t work then and it won’t work today. The end of the Depression only came with the build up in industrial activity, as the U.S. became the armory for the Allies in their battle with the Nazis. We had all better hope that the situation in the next couple of years will not require anything as dramatic and as destructive as World War II.

Economies are self-correcting. Government may ease the crisis, but the problem is that they arrive late to the party and try to rein in something that is already abating, usually with unfortunate and unforeseen consequences. Markets have no politics and are not partisan. Wall Street is (and always has been) a self-correcting mechanism. When President Roosevelt was inaugurated the people of the country were angry and frustrated, as well they should have been. On Inauguration Day, March 4, 1933, the DJIA were near their lows – 53.84. Nine years later, off of the worst stock market crash in the exchange’s history, the Index was 105.99, a compounded return of 7.8% – not a great return given how far the averages had fallen in the prior three and a half years. Unemployment in early 1933 was close to 25%. Five years later, unemployment was still 19%. It was the War, not the New Deal, which brought the Country out of the Depression.

Once again, it is not just Wall Street that is paying the price for over expansion in the 1990s and 2000s. Total employment is lower today than it was four years ago. GDP is up 7% since bottoming in June 2009, indicating a dismal compounded return of 2.6%. GDP has grown by $1.2 trillion, while federal debt has expanded by $6 trillion. Wall Street has been affected as well. The S&P 500 is 15% below where it was in October 2007 and 9% below where it traded in March 2000. Citigroup is selling 93% below where it was in June 2007 and 91% below where it was in March 2000, when the market first broke. Twenty years ago, the price of Citigroup was 14% above where it is today. JP Morgan’s stock price is the same as it was fourteen years ago, and 32% below where it was before the crisis began. The last dozen years have been punishing to the 100 million Americans who own stocks in their retirement plans.

Restitution is gradually being realized, irrespective of what happens in Washington. The spread between CEO compensation and average income remains substantially above where it was before options as compensation were first granted in the early 1980s (about 50 times.) But at 231 times it has declined from 411 times in early 2000, at the peak of the dot com bubble. The direction is likely to continue lower.

Dodd-Frank has put a damper on the cowboy capitalism that began in the 1980s, flourished in the ‘90s, was knocked to the canvas in March 2000, and which was finally KO’d in the fall of 2008. The seeds of destruction were sown, in part, during the “irrational exuberance” of the 1990s, and, as importantly, by the decision of the federal government to extend homeownership to those with little ability or inclination to pay. Risk without consequences always brings unhappy endings. Wall Street began down that path years ago when partnerships were converted to public vehicles. In that instance, risk accrued to shareholders, while employees reaped the rewards. Around the same time, banks began using derivative instruments, theoretically to reduce risk, but in reality to enlarge it. Derivatives provided position traders a false sense of confidence, encouraging them to leverage further already extended balance sheets. An unintended consequence of Dodd-Frank is that it has immunized the largest banks against current and future errors. The result is big banks becoming even bigger. And technology has allowed them to operate with fewer people; ergo the 200,000 + layoffs.

There will always be Fat Cats on Wall Street, just as there will always be cronyism in Washington, but the clowder of Fat Cats has shrunk. Maureen Farrell at CNNMoneyInvest recently wrote a piece, “Why Wall Street Hates Obama.” She is mistaken. Wall Street strongly endorsed Mr. Obama four years ago. This time they did not. Wall Street, like most, operates in its self-interest. It doesn’t hate. It rationalizes. People have emotions. Institutions do not.

While I do not mourn the passing of many Wall Street Fat Cats – those like Jon Corzine who used the system for his own advantage – I only hope that bright, aspirant and hard working young men and women will not be deterred from chasing and realizing their dreams. Their success helps all of us. We should never forget that democratic capitalism and the individual freedom that accompanies it have lifted all Americans – some higher than others – to increasingly higher standards of living. In his speech at Stanford, Richard Fisher reminded us of the pitfalls stemming from a too-intrusive government, the failure that comes from too much debt and an inability to reconcile our differences: “In the minds of many, our government’s fiscal malfeasance threatens the world’s respect for America as the beacon of democracy.”

The use of “mangy mutts” in the title is perhaps an exaggeration, but it was alliterative; and it reminded me of all the dogs of my childhood. (They weren’t mangy, but they were mutts.)