"The Rot At the Heart of Wall Street"

Real Clear Markets today gave this apt moniker to a fine piece by finance writer William D. Cohan, whose remedy for the rot is soooo simple:

What if every senior Wall Street executive had to worry that he could lose his entire net worth at any moment — including his mansions in Greenwich, Conn., and Palm Beach to say nothing of his job — if the revenue he was generating turned out to be unprofitable or excessively risky?

Does this loser-lose-all system sound impracticable today? Of course it does, given Wall Street's refusal to abandon the winner-take-all system that gave us the financial meltdown of 2007-2008. But as Cohan notes, Wall Street wasn't always addicted to risk: the Great Depression triggered a loser-lose-all system that worked just fine until 1970:

As with so many simple and obvious solutions, this one has the benefit of having a long track record of success. Once upon a time — not so long ago — this was how investment banking compensation worked. During the Golden Era of Wall Street, the years between the reforms of 1933 and, say, 1970, Wall Street was a series of small, private partnerships. If a firm made money in a given year, a partner would receive his share of the pre-tax profits. If the firm lost money, a partner was liable for his share of those losses up to and including his entire net worth. In those days, Wall Street stuck to prudent risk-taking.

Cohan's column then gives a nice overview of the risk-friendly corruptions than began in 1970 "when a small Wall Street partnership — Donaldson, Lufkin & Jenrette — decided to go public." His piece, modestly titled "Lehman’s Demise, Dissected" actually focuses on Anton Valukas' recent 2,200 page report documenting the off-balance sheet machinations of Dick Fuld (cropped to look evil, at right) and his crew at Lehman Brothers. Cohan's commentary on key passages of the report is here.

Robert Lenzner Critiques Larry Summers' new Social Compact between Wall Street and Main Street

Robert Lenzner at Forbes writes that Larry Summers "has a dream of a new social compact between Main Street and Wall Street - but no details." Summers, Lenzner notes, sounds serious:

In a sober warning, Summers noted that "roughly every three years for the last generation, a financial system that was intended to manage, distribute and control risk has, in fact, been the source of risk--with devastating consequences for workers, consumers and taxpayers."

Forbes describes Summers' social compact in a separate article. Lenzner continues:

So, what's Summers' prescription to deal with the crises to come? He is borrowing former Sen. Daniel Patrick Moynihan's solution for automobile safety proposed in the late 1950s when Moynihan was working for Averill Harriman in New York. The financial equivalent of "guardrails, shatterproof glass and speed limits," for Wall Street is Summers' clever model.

So where, Lenzner asks, are the details? There are none, he says. And in conclusion he offers this pessimistic and sweeping generalization about human nature:

Summers' idea to create a "social compact" between the financial community and the rest of the nation is pie in the sky. It has never existed and never will, I'd venture, because you can't regulate human nature.

Ugh - so is Wall Street exempt from the powerful government regulators of human nature in America that include schools, jails and police departments? Is Lenzner is granting exemption from regulation of human nature only in its intelligent free market aspect? Actually, I find myself thinking that Summers' idea of a social compact between Wall Street and Main Street may not be a idea. But if so, I suspect this social compact may be better realized voluntary communication between these two streets than government regulation of one of them.

In closing: today the New York Times editorializes on the much ballyhooed 90% pay cuts [and 50% compensation package cuts] to be imposed by pay czar Kenneth Feinberg on top executives at Citigroup, Bank of America and five other big banks that owe their survival to the U.S. taxpayer. Here's one observation:

If you read the fine print you will discover that these reductions apply only to the remaining two months of 2009.

Over and out.