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The Streak

Stocks are struggling, and the economy’s so-so. Why did Wall Street firms just have their best quarter ever?

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Bonus season may be eight months away, but Wall Streeters are already feeling frisky. Why? March brought record-breaking quarterly earnings reports from Goldman Sachs ($2.5 billion), Bear Stearns ($514 million), and Lehman Brothers ($1.1 billion). Even Morgan Stanley, the white-shoe black sheep, blew the doors off, earning a whopping $1.636 billion.Together, the four banks made more—nearly $5.75 billion in just one quarter—than the Gross National Product of the Bahamas, where many of their employees will end up on vacation.

And yet—traditional stocks are struggling, so your retirement portfolio isn’t zooming up along with the big boys. Even with the Dow close to breaking its all-time high—remember the year 2000?—brokerage units are generally struggling. Meanwhile, the Federal Reserve is still raising rates, and the yield curve has flattened. (Translation: The difference between long-term and short-term interest rates is virtually nil.) Both trends are generally bad news for big investment banks. So how are they so absurdly profitable?

Part of it is they’re living high off the rest of our penury. From unpayable Visa bills to overambitious real-estate mortgages, not to mention record government debt, the big Wall Street firms repackage debt and resell at a profit. (Lehman clocked record debt origination in the quarter and saw its fees from peddling corporate debt rise 26 percent from last year.) Then there’s the merger craze—i.e., AT&T buying BellSouth for $67 billion. (Morgan Stanley’s fees for dispensing sage advice on acquisitions were up 40 percent for the quarter.) And hedge funds, which are still booming, are generating gigantic commissions by buying and selling plain-vanilla stocks and bonds, and also fueling rapidly growing markets in Wall Street–produced exotica: collateralized-debt obligations, credit-default protection, custom-built portfolios, etc.

But the firms are not content to merely service hedge funds. Wall Street banks are now acting more like them, too. With each passing quarter, the firms are wagering increasingly large sums of their shareholders’ capital on stocks, commodities, energy, bonds—everything. At Goldman—a huge, highly profitable hedge fund lashed to a huge, highly profitable investment bank—“our principal strategies business also delivered record performance,” crows CFO David Viniar.

Indeed, the hottest new three-letter acronym on Wall Street may no longer be IPO or BMW. It’s VAR. That stands for “value at risk” and is a measure of how much of the firm’s capital is at risk of being lost on any given trading day. At Goldman, VAR is on the rise—$92 million in the first quarter, up from $65 million in the year before. “It is the highest VAR number we have had, but not the highest you will ever see,” says Viniar. In other words, you ain’t seen nothing yet.


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