Fixing Wall Street?
In the face of the myriad of problems affecting the financial world, Wall Street is embarking on a bold, and for it a mostly unprecedented, tactic. It is telling the truth.
According to Andrew Ross Sorkin in his Dealbook column in the May 13th edition of The New York Times, Kevin C. Griffin, the founder of the Citadel Investment Group, a twenty million dollar hedge fund, has put it rather bluntly: “We, as an industry, dropped the ball.” Mr. Griffin’s analysis is scathing: The investment banks gambled away money and jobs during the late great credit boom. The same bosses let the young, gung-ho traders take on too much risk and now we are all paying the price. In Mr. Griffin’s view, however, the answer is simple. The entire financial industry needs to change its attitude and perhaps accept greater regulation.
“As an industry, we have a responsibility to manage risk in a way that is prudent,” said Mr. Griffin. He is upset that Bear Stearns has failed. He is upset that key executives took on too much risk and then did nothing as billions of dollars of value vanished from balance sheets. He is worried about high priced finance jobs moving abroad. He has particular scorn for regulators in Washington D.C. who presided over what he called “the great depression on Wall Street.”
While speaking at the Milken Institute’s Global Conference in Los Angeles, Mr. Griffin attacked his own peers and trading partners. “When you read that UBS did not even view parts of its mortgage portfolio as having market risk, it becomes very obvious that a number of firms were not dotting the i’s and crossing the t’s when it comes to risk management,” he said during his panel presentation.
In Mr. Griffin’s view, one problem is the inexperience on trading floors that are full of twenty-nine year old “kids.” “The capital markets of America are controlled by a bunch of right-out-of-business-school young guys who haven’t really seen that much. You have a real lack of wisdom,” said Mr. Griffin.
Additionally, many chief executives of the universal banks or financial supermarkets “only understand a small part of the business,” Mr. Griffin said. He suggested that too many of them come from sales backgrounds. When you put these CDOS together with those young traders, you have the makings of an outright debacle.
Finally, the problem is compounded by weak government oversight. “The unwillingness of the Federal Reserve and the SEC to require working capital” limits, he said, further exacerbates the risk-taking environment. He described the banks as playing the equivalent of no limit poker. “The sad truth of the matter is it didn't have to be this way.”
Mr. Griffin doesn’t just complain; he comes up with solutions as well. First, “the investment banks should either choose to be regulated as banks or should arrange to conduct their affairs to not require the stop-gap support of the Federal Reserve,” according to Mr. Griffin.
He also wants new government oversight of credit default swaps. This business has a notional value and risk of 50 trillion dollars. In fact, it was the interlocking relationships between thousands of investors and banks over credit default swaps that pushed the Federal Reserve to rescue Bear Stearns from its own follies. Mr. Griffin wants the government to require use of exchanges and clearinghouses for credit default swaps and derivatives.
This will bring much needed transparency to the market. Investment banks will no longer play matchmaker between parties. Rather, an exchange will do it with strict rules in place, thus eliminating billions of dollars in exposure in creating this transparency. According to Mr. Griffin, this is what should have been done after the collapse of the hedge fund Long-Term Capital Management in 1998. He stated that it “is a very sad commentary on where we are from a regulatory perspective” that, ten years later, this move still has not taken place.
Mr. Griffin has not gone too far off the Wall Street reservation; he did include a warning that he does not want the pendulum to swing too far and erect regulatory regimes that would interfere with the playing field. He is particularly nervous about the drain of finance jobs overseas that could be exacerbated by excessive regulation.
Mr. Griffin’s comments, coupled with the admission by Jamie Dimon of JPMorgan Chase that the country is in a recession, may be the start of a new trend of forthrightness in finance. While we cannot say that Wall Street has uniformly adopted honesty as the best policy, at least a few of its spokesmen appear to be trying it on for size.
