Death by a thousand cuts

The banking industry in New York is dying. It is death by a thousand cuts and indiscriminate layoffs. If you ask Goldman Sachs, they are only top-grading, and getting rid of the bottom segment of the industry. In reality, the bottom feeders are really at the top, making these decisions to cut. The banking industry has been in-bred, and corrupted for years with crony capitalism, and nepotism being the main talents for survival. Anyone that has any real talent, capability, or ethics, has been systematically purged from the system.

So now we finally have the inevitable death throes of the industry. After facing the reality of the consequences of their actions in 2008, and refusing to accept this reality, finally Bankers are at a point where the golden goose is not laying any more eggs. So instead of trying to save the industry, they have decided to kill the goose, and make a last meal of whatever remains.

It is all fine in the free market text books, to allow for a hire and fire environment, that allows a bloated manufacturing firm to trim their costs, and remain competitive in a global environment. However, we are talking about banking and not manufacturing. These same banks were hiring last year. In reality, they have no idea how many people they need, because they have no idea as to their purpose in the economy. The Wall street firms are just serving up BS, and consequently there is no set number of people required to do this job. It is an extremely variable number.

The real reason the banks costs are high is because of the number of Managing Directors on the payroll. Do the math. If you have a thousand MD's earning over a million dollars a piece, that is a billion dollars in expense. It is hard to make any money when your costs are so high. Instead of turning out thousands of low level grunts into the streets, they need to lose the MD's. Since the MD's are the ones doing the firing, this is not likely to happen unless you have a very brave CEO.
Since the situation is as it is, we need the government to mandate (hey if the firms did what was good for them, we would not need big government to step in) that for every thousand workers they fire, they need to lose an MD.

The current situation is bad on many levels. Due to the bottom feeders having moved up to running the firm, they have no other talents besides surviving at all costs. They do not have any actual technical abilities to run anything. So after each round of firing, they have to go back in the market and hire some people back, because someone has to do the work! Then we go to the next round of firings because the MD cost situation will continue to be a drag on the firm. Which is why we are seeing these endless hire and fire cycles.

The other option that the firms are following, is to move all the support jobs offshore, so that atleast on a short-term basis, the cost situation is alleviated. Which brings us back to why this will kill the industry in New York. The derivative products that the banks are peddling,despite their fancy names, can really be whittled down to four or key five asset classes - Equities, interest rate derivatives like interest rate swaps, Foreign Exchange products, Commodities and the infamous credit derivatives. These products are pretty much commoditised on the front-end, and a used car salesman could peddle them. No real irreplaceable talent is required to trade or sell these products. The real technical know-how which differentiates one firm from another is in the infrastructure, systems, regulatory framework, Accounting and everything else that has been built-up in the Banking industry, over the last century. If all of these functions are moved offshore, then how long will it take your overseas competition to pick up the front-end of the business, and own the industry end-to-end ? All we will have left will be proprietary hedge funds, masquerading as brokers and Banks.

There was actually a brave soul at Lehman, who suggested that if the Bankers skipped their bonuses for one year, they could save the firm. He/she was laughed out of the firm. Obviously, it made more sense for the MD's to simply change the flag, and get paid by someone else, rather than sacrifice their bonus for one year and save the firm that had enriched them for so many years. Nothing can save this industry without a real change in the leadership.

Obama needs to print dollars

That is the only way out. Print more dollars and weaken the almighty dollar. There is no point trying to tax the rich. Firstly you cannot simply tax them on their assets just for being rich.. You can only tax income. Most of these people have their income tied up as carried interest in hedge funds. That is capital gain and not current income. The CEO's and other corporate highly talented people get paid in stock, or options - again capital gain. So there is no easy way of getting these people to share.

So, there you have it. Banks will not lend and the rich will not share the tax burden plus they have their tea party puppets peddling trickle down economics in Congress. That is a perpetual stalemate. If this was a game of chess, you would simply resign at this point.

Anyway, printing dollars is the best way to redistribute. Inflation will make your worthless homes more expensive relative to the mortgages. Stocks will go up since prices are in nominal dollars, so everyone's 401k will look a lot healthier. The dollar will weaken and make US goods more competitive. Saudi Arabia and China will lose the real value of their Treasury holdings - we will pause here to shed a tear for them. There you have done it - you screwed the banks on the mortgages, hedge fund managers on their billions stashed away in dollars and some other countries that you do not particularly care for. Sure grandpa's social security checks will be worth less but hey the current plan calls for throwing grandpa over the cliff anyway. This way will be somewhat slower.

So Obama, get your hands on that printing press...

Prime Broker lending

Dodd Frank is making a lot of noise about making sure that Banks and Broker dealers should put up enough collateral to fund their exposures. The setting up of exchanges to clear Otc trades is supposed to solve the "credit crisis" problem. But the real funding for Brokers and hedge funds happens in what is called the "Prime Brokerage " market. This is the cesspool that the regulators should really be regulating. All the money from the safe Banking vehicle, along with their excellent credit, gets channeled into their Broker dealer arm and on to this Prime Broker market. Here they sell this credit for Prime Broker fees from hedge funds and others, in exchange for funding.

So what you may ask, is the big deal ? This is some complicated mechanism that market participants use to fund their positions. Well the big deal is leverage, poor credit management and large exposures. The very problems that caused the crisis.

Lets start from the beginning. When a speculator, Hedge fund A, takes a position in a Bond, they do not put up the entire face value of the Bond. They borrow the money and buy the Bond, then enter a repurchase agreement with one of the Banks where they sell the Bond today and buy it back tomorrow, then take the cash and pay off their borrowing. Is that too complex - lets take a step back. I want to go long a Bond, but I borrow money from my banker friend to buy it, and then I do a trade with him selling it every night and buying it back in the morning. The difference in price between what I sell at night and buy it back in the morning equals interest that I pay my Banker friend for his kindness. If I do this with stocks, it is a little more expensive. Basically you buy the stocks, pay for it in cash, then you can lend the stock out in the stock lending market up to a maximum of 50% of the value of the position. You get 50% of your cash back, and pay down your borrowing by 50%.

The point of all this is that if you have the credit and relationships in the market, you can take any positions you want. When a Bank lends money, it needs to keep at least 8% of the face amount as regulatory capital. There are all kinds of rules being setup through Basel II & Basel III to make the Banks safe. But the real risk, which is in the Broker dealer market (remember Lehman was a broker- dealer) is simply not addressed. The Repo borrowing that I described above is not limited to “safe” Treasury Bonds. Basically, any kind of junk paper that is issued by the Banks through securitization, ends up in the Repo market. If a Broker/Bank issues a dud note backed by subprime mortgages, a hedge fund that bought that note would then turn around and give the same note back to the Bank, and ask for cash in the Repo market. The Bank/Broker that has one arm that issues the note and another arm that funds borrowings in the Repo market, cannot refuse to take back its own paper as collateral.

So net result is that the speculators can take all kinds of dangerous and illiquid positions and then have the Banks fund it through the Repo market. The Repo and Stock Loan funding markets need to be regulated to ensure that speculators do not take excessively risky positions. Leaving this market up to the self-regulation of Banks is leaving the Barn door open after the last set of horses have bolted and you just spent a ton of money buying new horses. The Bankers have every incentive to put the Bank at risk in exchange for prime broker fees. Hey, if the Bank blows up, we all know the terrible consequences. Basically you get a large Bonus for pulling the Bank through troubled times while Uncle Sam will step in to pick up the check.

Hey Dodd-Frank, nevermind over regulating the banks. Look at the Broker-dealer, Hedge fund Prime brokerage funding nexus.

The American dream is the root cause of expensive healthcare

So here is my thesis - I think this country is just too big. So we have all these small towns each with their own school, fire station, police station and hospital. This is just too expensive to maintain. Specifically healthcare, is really a luxury item. I was talking to this doctor friend of mine and asked him why medical services do not follow the law of economics. If a certain good becomes expensive you should be able to flood the market with supply and bring down the price of the good. So for instance, if doctors are expensive, why not import cheaper doctors from overseas and bring down the cost ? Paradoxically, for medical providers, the cost goes up when you increase the number of providers. The private healthcare system we have in place is based on capitation. This means that regardless of whether you fall sick or not, each doctor gets paid on capitation. They get paid per number of members, regardless of whether their services are used. So the trick to controlling costs is to reduce the number of providers. It is not possible to maintain a system of having millions of small towns each of them with thousands of podiatrisits, Physical therapists, all kinds of specialists and hospitals without causing a huge cost burden. So comparing the US healthcare system to any geographically smaller country's system is meaningless. We need to understand that maintaining the suburban life along with the availability of all these medical services, is a luxury. We can either suck it up, and pay for medicare, as it is a necessary item to maintian our standard of living. In that case, stop whining about the costs, and especially stop bitching about Obama's public healthcare plan. You do not want to create a system of haves and have-nots in healthcare. That is a recipe for social unrest. Otherwise, give up the current system and go to a National scheme that has fewer specialists, and other high-end doctors. This is what works for Canada, and other such systems. We cannot have it both ways.

Will New York be competitive in the future for Global Banking ?

Here is the problem with New York. Payroll taxes and healthcare benefits. The big global Financial centers currently are London, Singapore/Tokyo, & New York. Now that the dollar is depreciating fast against both European and Asian currencies, New York should be a lot more competitive versus these centers. However, Payroll taxes plus healthcare costs are going to put NY at a permanent disadvantage versus these other centers. This is not going away anytime soon. These costs add up to atleast a 50%+ additional cost to hiriing US employees versus its global counterparts. This is not fair to some extent because healthcare is subsidized by the state in these other economies, that does not get recognised as a direct cost for the company. Anyway, when did any of these businesses consider fairness in the equation?

So, for a multinational bank, it will always make sense to keep most of their support functions (which is the major job creator) in one of the other regions. The only people that need to stay in New York are the Sales people. This is just to service the rich clients and big corporations in NY. If these clients and corporates were to leave, to lower tax jurisdictions, that would be the end of the NY financial industry. Trading has already moved to the electronic world and traditional Traders are anyway giving way to machines. Sales can pretty much be done from anywhere. So long term, I can only see decline and urban decay, if New York continues to rely on the financial indsutry for its existence. The city will need to reinvent itself drastically if there is any long term plan to stay in business.

Why do Investment Banks hire and fire ?

The answer is short termism. The IB's and broker/dealers suffer from very short termism. A traditional bank takes in deposits, builds a reputation for cautious and prudent investment, and then lends to credit worthy counterparties for the long-term. However, an Investment Bank or broker/dealer makes all its money in fees...and gambling (also called proprietary trading). Consequently, they have absolutely no way of predicting their revenues for the next year. Sure, you can do back of the envelope calculations about the size of the market, and market-share. The truth is that the Shamans in their finance department, and their counterparts in Senior Management, have no clue as to their projected revenues. The best guesstimate is to take last year's numbers, and add a "stretch" target.

All these investment banks are run by former Salesmen. Their projections are always rosy and optimistic, and never really based on any objective assessment of the market. So, the only variable under their control is the operating budget which they use and abuse to make the numbers tie. So if the revenue numbers came in above estimate, as was the case last year, when the government was giving away free money, and the competition had thinned due to the crisis, all these IB's were on a crazy hiring spree. No long term need for it, no vision, no strategy. They held career super days where they hired fifty people in one day, to resource all kinds of grand expansion plans. Ofcourse, they made sure to pay themselves big bonuses for doing such a great job in puting together all the "talent". Now when the market came back to reality, and the revenues are nowhere near predicted, these same visionaries are on a firing spree. The long knives are out, and scores are being settled. Its every pirate for himself, and for his team ( these guys have gang affiliations that would put the Bloods and the Cripps to shame).

Anyway, do not buy all the BS about how they are upgrading and top grading etc. It is all about the money. The guys that have both hands in the till, are stuffing their pockets as fast as they can. Government regulation is so far behind that these guys will be long gone to their favorite secret island, by the time this next party is over. Onward to the next crisis!