[quote=Allan from Fallbrook]Dave: If you want to really underscore your point, set it in contrast to what the function of Wall Street is supposed to be: A means or mechanism to efficiently allocate capital where that capital will be most productive.
So how do we explain when all of that capital is egregiously misallocated and over a protracted period of time? I say, look to the compensation packages attached, especially the bonus structures, and it becomes patently obvious.
As odious as certain government regulations are and can be, a nearly complete lack of oversight only emboldened the various players further and deepened the effects of the crisis.
If you want an explanation of what is behind the agent/principal disconnect, look no further than pure, unfettered greed. Greed unhampered by oversight, regulation, ethics or simple common sense. It is completely impossible to have so much collective talent and business acumen so totally miss the obvious signs, unless they were incompetent, willfully ignorant and avariciously greedy.
There was no conscious sense of responsibility that these agents felt for their principals, anymore than the partners at Arthur Andersen Houston felt for the employees at Enron or the citizenry at large (CPA means Certified PUBLIC Accountant and you have an ethical and legal responsibility to act on behalf of not just your clients, but the general public as well).
House in the Hamptons, new Maserati, $2,000/hr escorts, cocaine, Cristal champagne and that custom made French yacht. Why be responsible to your clients when all those toys beckon?[/quote]
Agreed, however… recall that it generally takes two to tango. There were a lot of supposedly sophisticated institutions buying a lot of the dreck that Wall Street was selling. It wasn’t just wolves selling to the Little Red Riding Hoods.
Also, I know that there were a lot of frictional costs “lost” to Wall Street over the last decade. But I think some of this is overstated. A couple of examples. I saw some article recently stating that profits from the financial industry had increased by 2 or 3 times above the norm as a percentage of GDP. Yes, a lot of this came from “friction” (asset management fees, investment banking fees, etc.), but the lion’s share came from… interest received on much higher debt levels. About 75% of banking industry revenue comes from interest income, plain and simple. So as debt rises as a percentage of GDP – as it has, big time – then financial industry revenues as a percentage of GDP are going to rise… regardless of frictional fees. So, yes, all of the fee stuff is too high… but that stuff is a drop in the bucket compared to interest income off of higher debt balances. (Which is kind of scary as to what it suggests for where debt levels are. But we Piggs are already aware of this.)
Where friction is concerned I’ll use the equity mutual fund industry as an example. The average index fund charges about 20 bps in fees. I think the average active equity fund/investment manager charges about 100 bps (some are higher, obviously). The index fund fees are about as low as they can go. The active funds – forgetting about performance – should probably be at about 60 bps (and arguably less) to generate an economic profit for the manager. So, maybe there’s 50-60 bps of totally wasteful friction in the “traditional” investment management industry (that is, ex-hedge funds, private equity and index funds). If long LONG term returns on stocks are about 8.5%, that 50 bps is about 6% of the total return. Not good, don’t get me wrong. But not a disaster. Recall that in 1999, after a 17-year run in which the S&P 500 returned 19% annually, only cranks like John Bogle (I use the term “crank” in its most affectionate sense) were complaining about mutual fund fees.
Yes, investment banking fees are all too high, but again… these fees are small in the whole scheme of things. Although they seem absurd relative to the small group of folks that share in the proceeds.
But a lot of these fees are simply a result of folks “buying the dream.” Why do folks pay active managers high fees? They buy the dream that these folks can beat the market. Same goes for hedge funds and private equity funds. Same goes for brokerage fees generated through trading on behalf of clients. Why do companies pay eggregious investment banking fees? Because shareholders allow management to engage in silly transactions on which such fees are levied. And so on and so forth.
The bottom line is that there should be LESS: trading, M&A, offerings, active management, etc. There should be MORE operating and long-term investing. But that stuff’s not fun. It’s not sexy. Which is why there will always be a ton of friction for Wall Street to live off of. People love the dream. Hope springs eternal. And they’ll gladly pay for it.
