On The Wall Street Meltdown

In 2006, around the middle of November, I was working at a one of the largest brokerage houses on Wall Street, which shall remain, for this exercise, nameless. I had been working there for close to 8 years in various functions, the latest of which was as a junior middle market institutional sales guy.

I was at a party for my friend’s birthday, and at that party after a few drinks, we were talking about what normal Latino educated “elitists” talk about after a few drinks – politics and the economy. During that conversation I said to my friends “CDOs. That is going to bring this market down.”

To be sure I knew very little of what I was talking about at the time. CDOs were all the rage, and at my firms, they were THE premier product to sell, due to it’s high margin and apparent ability to return high yield with little risk. My friends asked me why, and I didn’t have a real answer, but I did say – “No one knows what these things are. But they are being sold like hotcakes. Clients have no clue, the banks don’t really have a clue, but as my boss made it clear to my team, “if you aren’t selling structured product, you ain’t sellin’”

It wasn’t till a year later, after I had left my firm and had attended that year’s version of the same event, did one of my friends bring up my apparent premonition. Now, I am no Miss Cleo, so this isn’t about that conversation. But this is about the last two years and how this crisis was waiting to happen.

There are going to be a lot of smart people, economists, politicians (except the ones running for president apparently) who will dissect this event and attribute it to a lot of causes. Regulation or deregulation, greed, the housing crisis, lax credit, etc. I will let them battle that out because most of this is “above my pay grade.”

There isn’t much I can say in terms of specifics of my experience during my last years in Wall Street, mostly because I’m sure I signed something that limits what I can say. But I will say that in general, the banks were ravenously competitive and struggling to maintain quarter over quarter and year of year growth, while the fees they could charge for most of their basic products, selling equities, bonds, mutual funds, etc, were in a perpetual free fall. Sell side research was, to put it mildly, difficult to value, and more clients could transact for next to nothing with online or prime brokers. In order to stay competitive and in the black, brokerages across wall street became more and more dependent on selling exotic securities, structured products like CDOs, credit swaps, etc, because they were high margin products (meaning lots of hidden fees) and couldn’t be bought and sold in the general market.

In a seemingly separate observation, Wall Street is generally known for its high turnover, but post millennium, that turnover became the standard. Entire sales/trading teams from other firms were poached along with their client lists, and restructuring of middle management seemed a constant. Loyalty to firm seemed a useless value, as most senior management came from other firms. There was a general joke that it was easier to move out than up, and I was given advice multiple times that if I wanted a significant pay raise at my firm, I’d be wise to leave, spend some time at a competitor, and than come back.

Another thing to mention was the business unit structure. For many at large brokerage firms, competition was heaviest not with other firms, but with other desks within their own team. To drive margin, P&L (profits and losses) were measured on a desk-by-desk, day-by-day, team-by-team basis. Any business coming from clients where credited to the desk. This often caused units to fight over clients especially when firms began to silo teams by product group rather than client. In my opinion, this produced a situation where short term wins and profitability overshadowed long term risk of a product or the market. It was about that day’s wins, and that team’s revenue. Not much else mattered.

To me, the combination of a virtually illiquid product understood by too few, sold by people with little institutional memory, who’s goals were about short term profitability over long term risk, spelled trouble. I think that was what drove me to start thinking that the future looked bleak.

A year later, the mortgage crisis is in full swing, and it was a matter of time before the underlying components of most of the structured products started to unravel. Most of the firms who did well selling these products did so in part by saying to clients they would always make a market in a security. Which usually implies (though not overtly due to regulation) “if you need to sell it, we’ll buy it back.” No one intended to actually HAVE to make a market during a crisis on everything they had previous sold to customers. But lo and behold, that happened. The structured desk who had produced superstars where now dragging the profitability of the entire firm, and with the amount of product that was in the market, it was a matter of time before these banks were crushed under the weight of their own making.

How this will play out is anyone’s guess. If I had to make a guess, stand-alone brokerages will be a thing of the past, gobbled up by mega banks and if they are lucky, able to function as subsidiaries.  But for me, this is very personal. I had drinks with a former colleague in a crowded bar filled with distressed looking suits. She told me how international clients were frantically removing all their exposure to US counterparts. She wondered if her function would survive in this post merger world, just as she was preparing to plan for children. A cousin who now lives in Miami told me she worked at one of these firms for almost 10 years and the money she set aside in her 401K was now all but gone. Another family member is sure to be unemployed. None of these people are the 335K salaried Wall Street royalty the newspapers like to portray. While that number may be the average salary, just like in the US, that number is heavily skewed by a decimal-percentage of people at the top, with the vast majority of people making much, much less a year.

Where do we go from here? We will see, however, I find it interesting how in a crisis many of the Wall Street leadership begs for government intervention, while they vote and lobby for Republican ideals of deregulation and tax breaks. It’s like the atheist who, now on a raft in the middle of the ocean surrounded by sharks, decides he had better begin to pray.

Those who vote with the conservative right talk about how they don’t want their tax dollars to pay for other people’s health care, yet here our tax dollars are paying hundreds of billions of dollars to bail out firms who’s demise was caused by their own risk/reward miscalculations.

Despite all this, no party can claim that they have a full grasp of these events or their ramifications. This is a tragic event on all accounts, as one of the pillars of America's service based economy is in the middle of a very public unravel.  We are truly in a precarious position when one of the foundations of our global strength can no longer hold its own.