“A large number of people cannot get on with their lives and their careers until we know what the rules of the game will be,” says John Coffee, a professor at Columbia Law School. “If you are a bank executive trying to plan for the future, you are not sure of precisely what you will be allowed to do. It is like a giant gin-rummy game where you don’t know which cards to pick up or put down.”
“Trading volumes are pretty low, and equity financings are hard. You add all that up, and you have an anemic top line,” says one private-equity executive. “At the same time, there are new rules bubbling out of Congress and the Basel Committee, and no one knows exactly what they’ll mean. There is going to be a lot of fighting over them and some unpleasant surprises.”
In some ways, Wall Street has fought a strong rearguard action by resisting reforms that would break up “too big to fail” institutions. Although the Volcker Rule has forced some to sell their proprietary trading desks, they remain mostly intact. The new Republican majority in the House of Representatives is trying to squeeze SEC funding and block Elizabeth Warren, the activist Harvard professor, from being confirmed as director of the new Consumer Financial Protection Bureau that she’s been running.
But behind these headline-grabbing events, there is a much bigger threat from the more technical-sounding reforms to derivatives trading contained in Dodd-Frank. These could submit the banks’ largest and juiciest businesses—their bond and derivatives operations that have operated off public exchanges, which makes it easier to charge investors more for each transaction—to public exchanges. There, prices can get forced down by the fact that they are easily compared and transparent. “The 1987 stock-market crash was a walk in the park compared with the credit-market meltdown. It had almost no impact whatsoever, whereas 2008 almost caused the end of the world. The over-the-counter credit markets are so much bigger and more important than the equity markets to large banks,” says Smith.
Whatever happens with any new regulation, there’s the bigger problem that maybe the entire economy, particularly in the U.S., isn’t getting any healthier. Bill Gross, the head of Pimco, the largest U.S. bond manager, recently sold all $150 billion in Treasury bonds he held in Pimco’s Total Return Fund, because of concerns about who would buy Treasuries when the Fed stops doing so to keep interest rates low.
Last month, financier Carl Icahn returned $1.76 billion in cash to investors in his fund, explaining in a letter to them that “while we are not forecasting renewed market dislocation, this possibility cannot be dismissed.” Since then, the uprisings have spread in the Middle East and Japan has experienced one disaster after another.
It’s going to be next to impossible to replace bonds and derivatives as all-you-can-eat revenue buffets for investment banks. At the 2007 peak, for example, Goldman Sachs was making four times as much from trading and principal investments as from its traditional investment-banking businesses such as mergers and acquisitions and equity underwriting. The entire shape of its business had altered since its IPO in 1999.
So what’s going to get the appetite going again? Bankers point hopefully to the $2 trillion of cash on U.S. corporations’ balance sheets. “Companies are sitting on enormous pools of cash, so eventually they have to do something with it,” says one. In fact, there are already signs of their doing so: AT&T’s $39 billion acquisition of T‑Mobile USA this week with $20 billion in financing from JPMorgan Chase cheered a lot of M&A bankers.
Investment bankers can also hope for an IPO revival, probably thanks to tech firms. There were an average of 530 IPOs annually in the U.S. during the nineties, but the figure fell to 61 in 2009, according to accounting firm Grant Thornton. Facebook’s IPO is expected next year—other Internet companies such as LinkedIn have already filed to go public. Both Goldman Sachs and JPMorgan have been trying to crack Silicon Valley by investing in companies such as Twitter and Facebook through private markets on which pre-IPO shares now trade.
That blew up in Goldman’s face when it offered to raise $1.5 billion for Facebook with a private placement of shares. Goldman had to close the offer to its U.S. clients, probably under SEC pressure, when the plan became known. Goldman had already upset some by charging hedge-fund-like fees: 4 percent up front and 5 percent of any profits. Jim Clark, a Silicon Valley investor, dismissed it to Bloomberg Markets as “just another way for them to make money from their clients.”
The arrangement was reminiscent of the way in which banks made money by selling shares on behalf of tech companies during the first dot-com bubble. They not only got paid by technology companies for underwriting their IPOs but also could allocate shares to clients who were most likely to give them other business. “There is a mind-set on Wall Street of wanting to gouge fees wherever they can,” says Tavakoli.