Wall Street as Wal-Mart? A few years ago, the Masters of the Universe never could have imagined their industry being compared to big-box retailing. And yet, the model that had fueled bank profits has finally broken, as markets sputtered and new regulation kicked in. “Compensation is never really going to come back,” a Wall Street headhunter told me. “That is something entirely new.”
What is even more startling about this reversal is that few thought the much-vilified Dodd-Frank act would have much effect at all. From the moment it was proposed in 2009, the bill was tarred from all sides. Critics from the left, who wanted a return of Glass-Steagall, which had kept investments banks and commercial banks separate until it was repealed during the Clinton years, howled that Dodd-Frank wouldn’t go far enough to break up the too-big-to-fail banks. “Dodd-Frank was an attempt to preserve the status quo,” Harvard economist Ken Rogoff told me. The too-big-to-fail banks, for their part, argued that the 2,300-page bill would create an overly complex morass of overlapping regulators that risked killing their ability to compete against foreign rivals. “We joke that Dodd-Frank was designed to deal with too-big-to-fail but it became too-big-to-read,” said the Citigroup executive.
By the time the bill passed, in July 2010, the legislation hadn’t found many new friends. Banks were especially upset by the inclusion of the Volcker Rule, which banned proprietary trading and virtually all hedge-fund investing by banks. Banks also complained about an amendment that slashed lucrative debit-card fees. They capitulated mainly because the alternative—breaking them up—was worse.
Part of the perception that the financial crisis changed nothing is that, in the immediate wake of the crash, the banks, buoyed by bailout dollars, whipsawed back to profitability. Goldman earned a record profit of $13.4 billion in 2009, as markets roared back from their post-Lehman lows. This dead-cat bounce was central to the formation of Occupy Wall Street and the neopopulist political currents that first erupted when the Treasury Department appointed Ken Feinberg to regulate bonuses for several TARP recipients. “The statute creating my authority was populist retribution,” Feinberg told me recently. “The feeling was, if you’re going to bail everyone out with the taxpayers, it has to come with a price.”
And yet, from the moment Dodd-Frank passed, the banks’ financial results have tended to slide downward, in significant part because of measures taken in anticipation of its future effect. Since July 2010, Bank of America nosed down 42 percent, Morgan Stanley fell 25 percent, Goldman fell 21 percent, and Citigroup fell 16—in a period when the Dow rose 25 percent. Partly, this is a function of the economic headwinds. But the bill’s major provisions—forcing banks to reduce leverage, imposing a ban on proprietary trading, making derivatives markets more transparent, and ending abusive debit-card practices—have taken a pickax to the Wall Street business model even though the act won’t be completely in effect till the Volcker Rule kicks in this July (other aspects of the bill took force in December; capital requirements and many other elements of the bill will be phased in gradually between now and 2016). “If you landed on Earth from Mars and looked at the banks, you’d see that these are institutions that need to build up capital and that they’re becoming lower-margin businesses,” a senior banker told me. “So that means it will be hard, nearly impossible, to sustain their size and compensation structure.” In the past year, the financial industry has laid off some 200,000 workers.
Nobody on either side would say that Dodd-Frank perfectly accomplished its aims. But while critics lament that no bank executives have gone to jail and have argued for a law that would have effectively blown up the banking system, Dodd-Frank is imposing a painful form of punishment. “Since 2008, what the financial community has done is kick the can down the road,” the senior banker added. “ ‘Let’s just buy us one more quarter and hope it gets better.’ Well, we’re now seeing cracks in that ability to continue operating with the structures that had been built up.”
To understand how radically Wall Street is changing, you have to first understand how modern Wall Street made its money. In the quaint old days, Wall Street tended to earn its profits rather boringly by loaning money, advising mergers, and supervising bond issues and IPOs. The leveraging of the American economy—and the supercharging of the financial industry—began in earnest in the early eighties. And banks have profited from a successive series of financial bubbles, each bigger and more violent than the one preceding it. “Wall Street did a really good job convincing people it was really complicated and they were the only ones who could do it and it justified paying them millions of dollars,” a former Lehman trader explained. Credit was the engine that powered the explosion in bank profits. From junk bonds in the eighties to the emerging-markets crisis in the nineties to the subprime mania of the aughts, Wall Street developed new ways to produce, package, and sell debt to willing investors. The alphabet soup of complex vehicles that defined the 2008 crash—CLO, CDO, CDS—had all been developed to sell more credit. “If you look at the past 25 years, the world economy was going through a process of leveraging,” a senior Citigroup executive said. “Debt has grown faster than economic growth. The banking industry was at the epicenter of facilitating the growth of credit creation. It drove every business.”