Snakes and Ladders: Investment Banking on the Brink

By Martin Hesse, Thomas Schulz, Christoph Scheuermann and

The financial district in London: Will tough times be enough to transform an industry? Zoom
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The financial district in London: Will tough times be enough to transform an industry?

Part 2: 'Less and Less Fun Every Day'

The machine in which W÷tzel worked made the banks rich and made it easier for the rest of the world to live on borrowed money. In the end, however, it began to destroy itself, generating one scandal after another.

Banks manipulated the LIBOR interest rate, which affects financial transactions worth hundreds of trillions of dollars. They foisted risky assets on customers and became involved in money laundering and tax fraud. Traders like Kweku Adoboli (UBS), JÚr˘me Kerviel (SociÚtÚ GÚnÚrale) and Bruno Iksil (JPMorgan Chase) gambled away billions through risky transactions, either on their own or with their departments.

Former German President Horst K÷hler once described the financial markets as a monster controlled by investment banks. Since 2008, politicians have been trying to tame the monster and assume control.

For instance, they want banks to set aside more capital as collateral for risky deals in the future, which means that many areas will hardly be profitable anymore. Banks and bankers are to be forced into a tighter corset -- but they are fighting back. The United States recently -- and yet again -- cast doubt on the chances of seeing new rules introduced. There is also heated debate worldwide over tighter regulation of bonuses, which are sometimes exorbitant.

"It gets to be less and less fun every day," says trader Peter Burger, who believes that the proposed regulations are almost as excessive as the banks' former dealings were.

Bankers are especially upset over the move to sharply curtail personnel costs. There is no other industry in which workers cost as much as in investment banking. "This is the only industry in which labor has exploited capital," jokes one adviser.

For this reason the mass layoffs at UBS -- which is completely abandoning large portions of its investment banking business following the appointment of Axel Weber, the former president of Germany's central bank, the Bundesbank, as supervisory board chairman -- are seen as a warning sign for the entire industry. It is "as if Daimler stopped making sedans," says the head of the German division of a major US investment bank.

The Safer Survivors

US investment bank Cantor Fitzgerald has already had to reinvent itself once before. It lost three-quarters of its staff, a total of 658 employees, in the 9/11 terrorist attack on the World Trade Center in New York.

Today, Cantor Fitzgerald has 1,600 employees in 30 offices around the world. The company survived not only the 9/11 disaster, but also the recent financial crisis. "We've just gotten much bigger and better," says CEO Shawn Matthews. One reason for this is that Cantor primarily deals in bonds, a sector that's booming now that companies with insufficient access to credit are raising more and more capital through bond issues.

Is this what the investment bank of the future looks like -- Cantor's modest office on the fourth floor of a nondescript office building in Manhattan?

Matthews says that his industry has to find its way back to how things still were in the 1990s, when bankers were compensated differently and such large amounts of debt were not in play. Things only became dangerous, he says, when investment banks transformed themselves from private partnerships into publicly traded companies. As a result, managers no longer felt that they were putting their own money on the line whenever they took major risks.

Cantor Fitzgerald is a privately held partnership with only a limited amount of capital at its disposal, and Matthews is visibly proud of that. "We don't have to worry about the pressures of quarterly (reporting)," he says, "so we have the ability as a group to determine how we can build long-term wealth."

Matthews is convinced that many small and mid-sized banks will completely disappear, partly because -- for the first time in decades -- the "next big thing" that would enable investment bankers to stir up the financial world isn't visible on the horizon. In the 1990s, it was derivatives and, most recently, it was complex mortgage-backed securities. But now the financial wizards seem to have run out of ideas.

"So you start to look at it from the standpoint of what is the new Wall Street," says Matthews. "It's still a great place to have a great living, (a) good lifestyle, the ability to clearly carve out a significant career, but not the world that was kind of the illusionary world that was created by infinite leverage."

But that place is still a long way away.

Smaller, but Still Plenty Risky

Roland Berger, a German management consulting firm, estimates that another 25,000 jobs will be slashed in the coming years as the entire industry rebuilds itself.

"The trend is fundamentally toward the sale of simpler, industrially produced products," says Markus B÷hme, an expert with Berger. These instruments are known as "plain vanilla," which is industry jargon for mass-produced and therefore requiring far less personnel.

But will the world of investment bankers truly become less risky?

"The investment banks will get rid of the traders, but not the books," warns Michael, a 35-year-old who worked as a trader of "exotic" products in London for 10 years after training to be a software engineer.

In the wild years, UBS's balance sheet, for example, was inflated with hedging transactions and bets worth 560 billion Swiss francs (€450 billion/$600 billion). The competition argues that downsizing the portfolio will be about as easy as shutting down the Chernobyl nuclear power plant.

Indeed, only a select group of experts understands what exactly is still lurking in the books of investment banks. "The formulas are simple; it isn't very high-level math," says Michael, "but you have to see the risks." The trick, he adds, is to recognize all contingencies.

Many investment bankers who are losing their jobs are also moving to hedge funds, where they now place their bets in the hidden world of the shadow banks. Others are looking for loopholes and new areas in which to ply their trade. Investment bank Goldman Sachs, for example, is engaging in risky deals for its own account, despite its insistences to the contrary. The bank's financial jugglers are circumventing a ban on such transactions in the United States by simply making bets for longer terms, which are not covered by the law.

Meanwhile, players such as JPMorgan are getting involved in the commodities market in a major way. Of all people, JPMorgan banker Blythe Masters, who became world-famous for the role she played in inventing the first credit derivatives, now heads the bank's global commodities division.

Things haven't changed much in the latest preferred sector of many investment bankers: At first, the banks only hedge against risks, but then they sell these risks and, to do so, they invent new and increasingly complex methods. Eventually, the volume they move around on the financial markets becomes so big that they acquire overwhelming influence. "If you ask me, this is the next scary thing," says one banker.

So is the system incapable of being reformed? Frankfurt personnel consultant Andreas Halin, who has been in the business for many years, answers the question with a telling comparison.

"Money is like saltwater," he says. "The more you drink, the thirstier you get."

Translated from the German by Christopher Sultan

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1. House of cards
banksis 01/19/2013
What I find intriguing is how long the house of cards took to fall. Is there any relationship between the industry's blind acceptance of the "need" to pay the financial cowboys so much on the one hand and the failure of the Catholic church hierarchy to see its brand being tarnished by the institutional failure to rein in errant priests?
2. ...
Newspeak 01/19/2013
"Not everything about investment banking is bad," he says. Surely true. It is the same thing old Nazis and communists will tell you about their systems. Capitalism is an inhuman ideology. Investment bankers are at the top of it. Its "elite". They should "pay" for their crimes. Every single one of them.
3. Regulation
kogiks 01/20/2013
Humans have invented regulations precisely because humans have an intrinsic predisposition to evil as well as to good. Investment banks are useful to society sans their abuses. Thus the trick is to simply ensure effective regulation of investment banks that they may conduct themselves properly and be a force for good in society.
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