The Best Sentence I Read This Week

“The dark days of deals are over. Financial institutions will have to decide if they want to be banks or if they want to engage in the risky financial trading that caused the collapse of firms like AIG.”

Okay, so it’s two sentences. More here, from the battle on financial reform taking place on the Hill. And here’s a paper I wrote a few years ago about the problem of credit default swaps.

It’s probably fair to say that the amount of lobbying dollars spent by the Wall Street banks in DC is directly correlated to the size of their profit margins under threat. So this is going to be one heckua fight. But let’s be clear – the debate over derivatives you’ll be hearing about in the weeks ahead has nothing to do with economic freedom, limiting customers’ flexibility, or any other rhetoric. Banks don’t want any transparency into derivatives because the margins are so large. Sunlight means less profit – full stop. And while there’s no bigger fan of profit than me, if it comes at the expense of pulling the wool over your customers’ eyes, then it’s fair to question how sustainable those profits really are.

Politics aside, I think the huge pushback the Wall Street banks are mounting to what really should be a no-brainer part of reform underscores one key insight for investors: these banks don’t have sustainable moats.

Whatever economies of scale they might have are dwarfed by the complexity of their businesses, and that scale is certainly not evident in their internal returns. While there are plenty of sharp folks who work for the big banks, from a business owner’s perspective, that’s kind of like seeing your competitive advantage walk out the door every night.

So a point that I think gets lost in all the rhetoric these days is that these banks are lousy businesses. I would have thought that obvious to anyone alive in 2008, yet somehow it is not. Wall Street banks don’t represent the best of American companies, nor do they have any interest in truly free markets. I suppose you might respect their power and their unique political connections, but they shouldn’t get any credit at all for building enduring businesses. And shouldn’t that be at least a little relevant here?

When it comes to financial reform, Wall Street banks certainly don’t deserve a seat at the negotiating table because they’ve earned it. They bought it. Here’s to hoping we see that change.

Update: Um, never mind. This is now the most amazing sentence I’ve read this week:

“U.S. Accuses Goldman Sachs of Fraud.”

Sounds similar to the Magnetar trade.

And from a political strategy perspective, this announcement is arguably brilliant in terms of timing. Not only has Goldman’s seat at the reform table imploded, but the other big banks just saw the height of their chairs drop by about a foot.

Well-played, Forces of Good. Now, break up the banks, and I’ll quit badmouthing you for at least a week.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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4 Responses to The Best Sentence I Read This Week

  1. Nice article you wrote back then. The Lincoln quote is so accurate – people forgot to be skeptical. Serves again as a reminder that being in a place where one has staying power with other consumption opportunities that compete with investment opportunities gives a perspective that allows one to make a true choice about whether or not each investment is worth the time/risk. Seems like so few stepped back and really looked at what was going on.

    • Cale Cale says:

      Agreed, Arthur. I finally got a copy of The Big Short last night – about those few who did step back and really look at what was going on. Fascinating. Also just finished 13 Bankers, which I’d highly recommend to anyone who is not sure how skeptical of Wall Street they should be…

  2. Kirk Kinder says:

    You are so right about these firms not being good businesses. Just look at the monster earnings they are pulling down right now. It isn’t from actually banking. It is all proprietary trading and investment banking. We have essentially backed up hedge funds with taxpayer dollars via the Fed.

    Any industry that requires darkness is doomed. Realtors fight to keep the MLS from being a simple website that can be queried by anyone. Car dealers fight to keep people from knowing what their true cost is for the car on the lot. But, these industries are struggling as the internet lets information flow. If CDS or other instruments were put on an exchange and transparency flourishes, the banks will see profits collapse.

    • Cale Cale says:

      It’s as if the banks are held hostage by their employees, too. I find it hard to believe they’re so obtuse that they continue to pay out half of those earnings as compensation and/or bonuses despite the public flak they’ll take because they think they truly deserve it. Well, maybe the Goldman guys do. But I think those management teams know that if they don’t shower their key guys with money, then they’ll just go join the firm across the street. And that scares the hell out of them, because (1) they really have no idea what their guys do all day, but they fear that (2) those same guys could destroy the trading books they just created once they’re working at another firm.

      Wall Street the last few years has been like Major League Baseball in the late 90’s. Both were like some twisted sort of social experiment. What kind of behavior can you create in people after showering them with tens of millions of dollars they really don’t deserve?

      Steroids? No problem. Defraud your own customers by a billion dollars? Apparently so…