The fatal banker’s fall

By John Gapper

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Bankers have never been popular, but Washington’s rejection of the $700bn bail-out for banks on Monday recalled the odium that attached to them in the Great Depression.

Americans rightly wonder why their taxes should be used to rescue bankers from their folly. In the 1930s, bankers were called “banksters” – to rhyme with “gangsters” – as a result of 1920s swindles such as the sale to small investors of Peruvian bonds that became worthless.

It is odd, as well as infuriating, that investment bankers managed to take the public for such an expensive ride again. Only 10 years ago, the author Ron Chernow declared the “death of the banker”, arguing that Wall Street’s grip on the financial system was ebbing.

Yet here we are again – this time with governments around the world opting to rescue banks rather than risk economic disaster.

At the risk of repeating Mr Chernow’s mistake, however, this crisis will truly kill the banker. By that, I mean it will end the reign of the investment banker as society’s leading figure of wealth and influence, cutting a swath through the world and being deluged with money.

Does this make the rest of you (not the bankers, I mean) sad? No, I did not think so. I know plenty of likeable and ethical bankers, but as a general rule, they are in disrepute.

Wall Street’s behaviour during the mortgage boom bears a nasty resemblance to that of Charles Mitchell, the head of National City Bank, which sold dodgy securities to Main Street in the 1920s. Mr Mitchell turned National City’s broking arm into a securitisation machine.

John Brooks, author of Once in Golconda, records Mitchell boasting before the 1929 crash: “We have … a large force devoting itself to the manufacture of long-term credits suitable for public distribution.” This paper included Latin American bonds and shares in flimsy companies.

The same could have been said in the past five years by Wall Street banks, which turned mortgage loans into securities and sold them to investors. They got the raw material for their factory from Main Street, where 1m estate agents and brokers cajoled people to buy houses.

With hindsight, Wall Street was operating a giant scheme to turn equity in Main Street houses into fees and bonuses. Dealbreaker, the finance blog, calculates that house sales and mortgage securitisation generated roughly $2,000bn in fees between 2003 and this year.

With this sort of money washing through the system, it is hardly surprising that Wall Street became such an attractive – and large – employer for many bright and ambitious young people.

When I left university, few graduates thought of going into “merchant banking”, as it was then known in the UK, and almost no one into stockbroking. In recent years, however, investment banking has become the first place for graduates to seek their fortunes.

Employment in the US securities industry has more than doubled since the downturn that followed the 1987 stock market crash – from 417,000 in 1990 to 867,000 this year.

Many of those jobs – and much of the bonus pool that supported them – are at risk. I do not think investment banking will regain its hegemony for a very long time, if ever.

Wall Street veterans will smile and shake their heads at this point. Has their industry not shown, time and time again, its ability to shrug off downturns and disgraces by curtailing one business and replacing it with another bonus-generating activity?

When underwriting commissions were squeezed in the 1970s, it turned to selling shares to mutual funds. In the 1990s, profits came from mergers and acquisitions and retail investing. When the technology bubble burst, Wall Street discovered mortgages.

If you put a lot of clever people in a room and promise them big rewards for coming up with fresh ways to make their banks money (also known as “financial innovation”), they can be surprisingly creative.

But it is hard to imagine Wall Street dusting itself off and getting back to business as usual this time.

For one thing, bankers’ unpopularity – with politicians, regulators and the rest of us – has been propelled to greater heights than before by this crisis. How others regard you is not a matter of life or death – I, after all, am a journalist – but it will hurt the industry.

Furthermore, banks cannot employ so many people on such good terms in future. In the credit bubble, investment banks grabbed ordinary bank lending and turned it into an overly complex business that employed thousands.

As commercial banks swallow up Wall Street investment banks, lending will revert to a routine business that does not throw off enough fees to support a Wall Street lifestyle. Nor will any new business easily take the place of mortgages. Mr Chernow argued in The Death of the Banker that transparency – starting with the 1933 Securities Act – had steadily narrowed Wall Street’s profit-making opportunities.

In mortgages, Wall Street found a magical combination of financial leverage and lack of transparency, since mortgage securities and related derivatives are over-the-counter instruments. That allowed investment banks to make money from information-starved investors.

The Wall Street banks that are left will try to find a replacement, of course. But it will be next to impossible to find a new business as large, and with such profit potential, as credit securitisation.

This will mean the death of a lot of bankers. It may not provide as much pleasure as killing all the lawyers. But it is a start.

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