Wait, So How Did Big Banks Go From Being Dead Broke to Having Billions for Bonuses?

Photo: istockphoto

Isn't it amazing? Wall Street has gone from being dead broke one minute to making money hand-over-fist! After a 2008 that was, shall we say, a bit rough around the edges, the universe has apparently been remastered, and the first-quarter profits of the largest financial institutions have enabled them to put aside cash for bonuses on par with those of the halcyon days of 2007, when the world was already falling apart, but didn't yet know it, and making big money on Wall Street had not yet inflamed the masses.

How did they do it? As we all know, every winning trade must have a corresponding loser, so someone's pockets are being picked. Whose?

A clue was provided last week when banking analyst Brad Hintz criticized Morgan Stanley for not using sufficient leverage to exploit its "excellent flow trading results" in fixed income, a.k.a. bonds.

Apparently, Goldman Sachs made $6.56 billion trading bonds, while JPMorgan scored $4.9 billion.

We had no idea what "flow trading" was, but we sure liked how it sounded. So easy, so smooth. Maybe we could do it, if only we knew what it was. So we asked a friend who works at a hedge fund to explain. "Basically it means that the bond market was in such disarray, the big banks were able to rip off their customers without the customers knowing," he told us, via email.

Oh. He went on:

"For example, in a boring bond market, a bond might fluctuate over a full year between 98 and 102, let's say.

So, if I trade that bond ... the broker-dealer might make a market 99 to 99.25 and hope to work for a quarter point. (I pay 99.25, the guy who sold it to the dealer got 99 ... the dealer makes .25 (effectively half from me and half from the seller.)"

We took some time, we won't ever admit how long, to digest this, and soldiered on.

Now let's put the market into disarray ... and that bond (usually a boring thing) ... falls from 100 to 65 in two months.

On any given day, I might get to pay 72 and the fellow selling might get 70 and the dealer makes two full points. The market isn't that transparent, and the dealers charge what they can get away with. In a disconnected market, fear and greed take over. The seller is more anxious to sell and the buyer is more anxious to buy, and dealers take advantage. In the previous example the dealer needed to trade eight times as much to make that. So, by being in the flow, the dealers make a fortune in a disconnected market."

Okay, we try not to be willfully naïve about how the world works, but this kinda makes us want to hurl. We understand that buying and selling in these volatile times entails extra risk, and traders ought to be properly rewarded for that— IF ONLY THESE RISKS WERE NOT BEING BACKSTOPPED BY THE U.S. TAXPAYER! (Sorry, we needed to bust out the all-caps). You know what they call this? Gouging. The market dislocation that Wall Street is now profiting from was caused by Wall Street, and should the renewed spirit of risk taking, heaven forbid, somehow backfire and result in more losses, you can easily guess who's going to get stuck with the tab.

After Off Year, Wall Street Pay Is Bouncing Back [NYT]